Manufacturing Renaissance Meets Time-Inconsistent Tariffs

We analyze optimal tariffs in a dynamic version of the Venables (1987) framework with a time-to-build lag in firm creation. In this environment, trade protection is driven by the desire to increase firm creation at home at the expense of the foreign trade partner. When firm creation takes time, the benefits of protection accrue in the future, whereas the costs in the form of higher consumer prices occur immediately. Under certain parameterizations, a policymaker that can commit to a full time path of tariffs leaves trade unrestricted at date 0, and announces high tariffs coming on at a pre-specified future period. But there is a time inconsistency: the policymaker's short-run incentive is not to impose contemporaneous tariffs due to the adverse effect on prices. Thus, lack of commitment to future tariffs can preserve free(er) trade and derail a manufacturing renaissance.