Optimal Commercial Policy with International Returns to Scale

This paper examines the implications of international returns to scale and globalization of production for commercial policy. Though national returns justify subsidization for small countries, the first-best policy for small countries acting on their own under international returns is free trade. However, a coalition of such small countries can justify an active, interventionist commercial policy, even when it is unable to manipulate world prices. In general, optimal subsidy rates for increasing returns sectors are greater for a coalition than for its members when acting on their own when terms-of-trade effects are controlled for.