Tariff Policy for a Monopolist in a Signaling Game

We examine the incentives for a government to levy an optimal tariff on a foreign monopolist with unknown costs. With complete information, the home government uses tariffs to extract rents and implements a discriminatory policy that imposes higher tariffs on the more efficient monopolist. If the government is incompletely informed about costs, we show that under reasonable conditions the unique self-enforcing outcome involves pooling where the firm exports the same quantity regardless of its efficiency. Due to the distortions created by incomplete information we find that in general home country welfare is higher under alternative policies such as uniform tariffs or free trade than under one of discriminatory tariffs. Our results suggest that trade policies that are motivated by rent extraction are unlikely to be robust to the introduction of incomplete information