Optimim Tariffs and Retaliation: How Country Numbers Matter

This paper identi es a new terms-of-trade externality that is exercised through tari setting. A North-South model of international trade is introduced in which the number of countries in each region can be var- ied. As the number of countries in one region is increased, each government there competes more aggressively with the others in its region, by lowering its tari , to attract imports from the other region. In doing so, all countries in a region exert a negative terms-of-trade externality on each other, collec- tively undermining their own terms of trade and welfare. This externality can increase e ciency if the numbers of countries in both regions are increased simultaneously.