Tariff Revenue, Government Expenditure and Growth in a Small Open Economy

I develop a small open endogenous growth model with domestic and foreign intermediate goods. The Marshallian external economies in the domestic intermediate goods sector work as the engine of sustained growth. The model offers two arguments. First, imposing a trade distortion is growth- and welfare-improving if the government uses the tariff revenue for correcting the domestic distortion. Second, comparing the tariff with a lump-sum tax as a financing device, the former is certainly worse than the latter with respect to both growth and welfare if the two intermediate goods are substitutes.

JEL Classification Numbers: F43, H20.