Duty-free zone, unemployment, and welfare a note

Abstract

We consider a small open Harris-Todaro economy with the urban sector consisting of a “duty-free zone” and a “non-duty free zone.” There is no capital mobility between the urban sector and the rural sector, but capital is perfectly shiftable between the two sub-sectors of the urban sector. A policy of expanding the duty-free zone through the reduction in import-duty on intermediate goods in that sector ultimately lowers the level of output of that sector. This policy also raises the level of unemployment, lowers national income (social welfare), and increases economic inequality. If, however, the tariff on the final product is reduced in that sector, we get the opposite result.