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Intermediate goods and the formation of duty-free zones

Authors
Journal
Journal of Development Economics
0304-3878
Publisher
Elsevier
Publication Date
Volume
25
Issue
2
Identifiers
DOI: 10.1016/0304-3878(87)90091-5
Disciplines
  • Economics

Abstract

Abstract If a country forms a duty-free zone by lowering tariffs on intermediate goods and taxes on foreign capital used in the zone, then resources are attracted from the surrounding domestic zone. This can worsen the effects of the distortions due to the tariffs remaining in the domestic zone and can lower the host country's national income and welfare. This tends to occur if: (1) there is less substitutability between the intermediate and labor than between these factors and capital, (2) there is currently a small foreign-owned sector in which the share of labor in total costs is large relative to the share of the imported intermediate in the foreign sector and relative to the share of labor in total costs in the domestic zone. Ironically, under the latter circumstances, the host country is likely to regard a duty-free zone as an attractive option.

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