This paper examines the pattern of trade in used asset markets where firms have differing factor prices and utilization rates of capital goods. Depreciation is modeled as an increase in down time as machines age, and a measure of comparative advantage is derived that will explain the pattern of trade when there are two types of firms. It is shown that with heterogeneous firms, the price of used machines will reflect the characteristics of firms as well as the productivity of used machines, and the implications of this result for the study of depreciation are discussed. Finally, the relationship between firm characteristics and choice between purchasing new and used truck tractors is presented as an illustration of the predictions of the model.

We analyze the efficiency and market equilibirum effects of endogenous categorization, where insurance companies classify risks on the basis of insureds' voluntary consumption of products that are correlated with underlying loss propersities, and we show that the use of such categorization may permit the attainment of first-best allocations as competitive Nash equilibria. The optimal insurance premium involves a trade-off between the use of categorization to correct moral hazard externalities generated by the consumption of the product and the use of differential consumption to sort heterogeneous consumers, thereby mitigating the social costs of adverse selection. The efficiency consequences of taxing or subsidizing aggregate, as opposed to individual, consumption is also considered.

There is abundant evidence that the production process of firms is becoming increasingly fragmented internationally, in the sense that a final manufactured good will consist of parts that have been manufactured in a variety of different countries. Studies of manufacturing industries suggest that the share of imported inputs in international trade rose significantly in the 1970's and 1980's, and that the fragmentation of the production process has been particularly pronounced in industries such as transportation equipment and electrical machinery.1 What difference does it make if trade reflects a fragmentation of the production process, rather than the traditional horizontal specialization in final goods? In this paper I focus on the implications of fragmentation for the analysis of commercial policy and emphasize two features of vertical relationships.2 The first is the market linkages that are introduced in models of fragmentation due to the interaction between tariffs on final goods and tariffs on intermediate goods. The incentives of countries regarding tariff reduction can vary significantly depending on the pattern of trade. The second feature of vertical specialization is that producers of final goods often require inputs that are specialized to their particular needs, so that vertical relationships may create contracting problems because of the possibility for opportunistic behavior. Commercial policy may play a role in altering the form of these vertical relationships.

This paper examines the pattern of trade in used asset markets where firms have differing factor prices and utilization rates of capital goods. Depreciation is modeled as an increase in down time as machines age, and a measure of comparative advantage is derived that will explain the pattern of trade when there are two types of firms. It is shown that with heterogeneous firms, the price of used machines will reflect the characteristics of firms as well as the productivity of used machines, and the implications of this result for the study of depreciation are discussed. Finally, the relationship between firm characteristics and choice between purchasing new and used truck tractors is presented as an illustration of the predictions of the model.

This paper uses recursive methods to characterize the payoff frontier of self-enforcing trade agreements between countries of asymmetric size. We show that at points on the frontier where only one country's incentive constraint binds, the efficient agreement will be a non-stationary one that starts with a positive trade distortion but eventually reaches free trade. Our analysis illustrates how (i) relative country size, (ii) consumption smoothing incentives, and (iii) sunk investments affect the form of efficient trade agreements. In contrast to previous work on gradualism, our results are obtained from a model in which the economic environment is stationary.

This paper extends the effective rate of protection measure to include the effect of investment incentives on resource allocation when capital is mobile internationally. This measure illustrates how investment incentives (such as capital grants and tax holidays) serve as another form of non-tariff barrier that may be substituted for tariffs in the protection package. Calculations made for the case of Ireland indicate that the substitution of investment incentives for tariffs after Ireland's entry into the EEC left the ranking of industries on the basis of effective protection to labor unaffected by the tariff cuts. R ECENT work on commercial policy has suggested that the pattern of tariff and non-tariff protection is the outcome of a political process, and reflects the profitability of protection to domestic producers and the costs of organizing producers.' In such an environment, reductions in tariff barriers negotiated outside the domestic political process (as in multilateral tariff reductions or entry into a free trade area) should result in political pressure by producers for the substitution of non-tariff barriers in the protection package. For example, Marvel and Ray (1983) argue that the Kennedy Round tariff cuts overstate the amount of trade liberalization that has occurred in the United States because of the erection of nontariff barriers that have partially reduced the effect of the tariff cuts. The purpose of this paper is to develop a comprehensive measure of protection, capturing the extent to which trade policies (tariffs and quotas) and investment incentives provide protection to domestic resources, and to present an illustration of the substitution of investment incentives for tariff protection following Ireland's entry into the Common Market. Investment incentives provide an alternative form of protection which may be important in countries where governments are constrained from altering tariffs, or where subsidies to export industries are limited by the likelihood of countervailing duties. Section I presents the rental cost of capital model, which can be used to combine the effects of various types of investment incentives (such as capital grants, tax holidays, and accelerated depreciation allowances) into a single measure that indicates the effect of these incentives on the cost of capital services to firms. This measure extends earlier work by Kopits (1975), Hufbauer (1975), and Guisinger and Kazi (1978), and can be used to make international comparisons of the level of investment incentives. Section II incorporates the rental cost of capital index into Corden's (1966) effective rate of protection measure when capital is mobile internationally. The resulting effective rate of protection to labor includes both output market distortions (tariffs and quotas) and factor market distortions for mobile factors (investment incentives). Therefore, reductions in tariff protection can be offset by increases in factor incentives to maintain the same effective rate of protection to labor in an industry.2 Section III provides a calculation of effective rates of protection to labor in eleven Irish manufacturing industries in 1966 and in 1977. Between these two years, tariff protection declined substantially following Ireland's accession to the Common Market. During the same interval, Ireland undertook a major reorganization of the Industrial Development Authority, armed with a wide array of fiscal incentives and charged with increasing industrial investment. We demonReceived for publication January 26, 1984. Revision accepted for publication July 5, 1984. *The Pennsylvania State University and University of Texas at Dallas, respectively. The authors wish to acknowledge useful comments from Malcolm Gillis, Ed Tower, Bee Roberts, and two anonymous referees on an earlier draft. We are particularly grateful to Dermott MacAleese, who provided us with unpublished data on protection in Ireland. The authors began work on this topic while serving as consultants to the International Finance Corporation. The views expressed .are not necessarily those of the World Bank or its affiliates. 1 Caves (1976) and Pincus (1975) find some support for the role of political pressure groups in tariff policy, and Ray (1981) broadens the analysis to include both tariff and non-tariff barriers. Takacs (1981) and Finger, Hall, and Nelson (1982) also find political variables important in escape clause and less than fair value cases. 2A recent study of the investment strategies of multinational corporations conducted for the World Bank (Guisinger (1983)) found that in the majority of cases examined, host country incentives were the determining factor in the location decision. The World Bank study defined incentives broadly to include both tariff protection and investment incentives, as our measure suggests. For previous work on the effect of tariffs on multinational location decisions see Horst (1972) and Orr (1975).