Non-Spill-over externality and Pareto Optimal Tariff policy of Internalization

Abstract

An equilibrium by free trade policy does not satisfy Pareto optimality or Pareto efficiency when there is domestic distortions like non-spill-over externality in trading partner country who do not or could not deal with those externalities by any kind of measures or policy. Even if exporting countries with externality as trading parter could not adopt any response to those externality, Pareto optimality can be satisfied through tariff measures taken by the exporting country and importing country cooperatively. Under the condition above, export tax rate by exporting country plus import tariff rate by imporing country should be the rate of tariff rate of internalization of the externality.