The Costs of Industrial Protection Under Tariffs and Subsidies

Policymakers often intervene in markets to protect domestic producers against foreign competitors. Two such interventions are import tariffs and production subsidies, both of which are, in general, costly. Tariffs on foreign producers, while generating revenues for the policymaker, may impose economic costs in the form of higher prices for consumers and downstream industries. Subsidies to domestic producers may require substantial upfront outlays. In this paper, we study the relative magnitudes of these costs in the context of the Indian utility-scale solar sector. The Indian government, in recent years, has relied on both import tariffs and production subsidies to support the domestic solar module manufacturing industry. Using a structural model of the solar module industry and its downstream counterpart -- the solar power plant industry, we quantify the short-run costs of expanding the size and share of domestic module manufacturing. We find small net costs associated with production subsidies and much larger costs associated with import tariffs. Specifically, in our main counterfactual, we find that expanding domestic output using just import tariffs reduces welfare by 46% relative to baseline, while doing so using just production subsidies reduces welfare by less than 1%