Trade Reform and Intermediation

This Chapter constructs a competitive general equilibrium trade model for a small open economy in presence of a protected intermediate sector and analyze the effectiveness of trade reform where bureaucratic corruption arises because of trade protection at the border. Intermediaries are employed by the domestic final good producers in order to avoid paying the import tariff. I use an HOSV kind of framework to prove whether trade liberalization necessarily leads to a contraction in intermediation activities. I then find that labor intensity of the exportable commodity which uses the intermediate good is critical factor in determining the extent of corruption. In other words, it is essentially a tug of war between higher tariff revenue and higher wage in the new equilibrium. Thus, the primary message is that trade liberalization may not lead to less corruption.