The Impact of Optimal Tariffs and Taxes on Agglomeration

1 Introduction

The Uruguay Round has reduces tariffs reasonably, although protection still
remains on a substantial level. Exceptions are mainly the large customs
unions like EU and NAFTA within tariffs have been eliminated while outer
tariffs tariffs are still reasonably. Though the EU, for instance, is char-
acterized by an average tariff level of only 3.3% a few industries like tex-
tiles, clothing, leather goods and automotive industries are protected much
stronger. Furthermore, corresponding import tariffs of the EU trade part-
ners are, on average, 5 to 6 times of the EU-level (Francois, Glismann and
Spinanger, 2000).

Justifying tariffs theoretically can be done either by the classical large
country assumptions or by rent shifting arguments of the ’new trade the-
ory’ (e.g. Flam and Helpman (1987), Gros (1987) or Brander (1995) for an
overview). Since the new economic geography (NEG) relies on very simi-
lar assumptions than new trade theory, namely monopolistic industries, the
question arises whether also in these kind of models an incentive for tariffs
exists and, in particular, how tariffs may affect the development of regional
inequalities. Answering this question within a theoretical NEG-model is the
main goal of the paper.

The development of the NEG has been initiated mainly Krugman (1991)
with the goal of explaining sustainable income differences between regions
or countries (e.g. surveys of Puga and Ottaviano (1998), Ottaviano (1999),
Masahisa and Thisse (1996) and Fujita, Krugman and J.Venables (1999)).
Although a broad variety of contributions have been derived so far the forces
of driving agglomerations are almost identical: Positive externalities are
emerging if industries and firms cluster together and the relative impor-
tance of externalities matters the more, the less important trade barriers
are, such that falling trade costs, for instance by integration, make a sustain-
able core-periphery equilibrium more likely. Mainly for technical reasons,
trade costs are usually considered to be of the iceberg-type according to
Samuelson (1954), meaning that trade causes expenses without creating in-

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