Trade reform, intermediation and corruption

- We construct GE model with a protected intermediate sector and corruption.
- Intermediaries are employed in order to avoid paying the import tariff.
- We use an HOSV framework to check if trade liberalization reduces intermediation.
- Labor intensity of the exportable commodity is critical for the extent of corruption.
- It is a tug of war between higher TR and higher wage in the new equilibrium.

We construct a general equilibrium model with a protected intermediate sector and analyze the effectiveness of trade reform for a small open economy where bureaucratic corruption arises because of trade protection. Intermediaries are employed by the producers in order to avoid paying the import tariff. We use an HOSV kind of framework to prove whether trade liberalization necessarily leads to a decline in intermediation activities. We find that labor intensity of the exportable commodity which uses the intermediate good is critical in determining the extent of corruption. It is essentially a tug of war between higher tariff revenue and higher wage in the new equilibrium. Thus trade liberalization may or may not lead to less corruption.