Trade Liberalization in the Presence of Foreign Direct Investment and Tax Credits: Estimates for Costa Rica

The paper uses a calibrated general‐equilibrium model to quantify the welfare impact of trade liberalization—and compute the optimal tariff structure—for Costa Rica when trade‐policy‐induced foreign direct investment and international capital taxation with credits are present. It shows that complete trade liberalization reduces Costa Rica's welfare, as it leads to an outflow of capital and loss of tax revenue which more than offset the efficiency gains from an enhanced resource allocation. The optimal tariff structure for the Costa Rican economy turns out to be a mixture of relatively small import tariffs and subsidies.