Nontariff protection without an outside good

- Intra-industry trade models with outside goods are often used in the literature.
- Removing outside goods, we reexamine the effects of unilateral nontariff protection.
- It is neither price-index lowering nor welfare improving in the one-factor case.
- Unless the elasticity of substitution is too small, it holds in the two-factor case.
- The outside-good assumption is not harmless to evaluate trade policies.

Assuming an outside good, the existing intra-industry trade models show that the domestic price index is lowered and the welfare is improved by unilateral nontariff protection against foreign products. Removing the outside good, we reexamine this issue incorporating the factor-price changes to capture the terms-of-trade effect. In the case of one production factor (immobile labor), we find that unilateral protection is neither price-index lowering nor welfare improving. In the case of two production factors (immobile labor and mobile capital), the same result holds if the elasticity of substitution between varieties is as large as that observed in empirical studies. Therefore, the outside-good assumption is not harmless to evaluate trade policies.