Shortages of Critical Goods in a Global Economy: Optimal Trade and Industrial Policy

This paper studies the role for optimal trade and industrial policy to mitigate shortages of critical goods following global shocks. We develop a dynamic model of trade with producers of essential and non-essential goods owned by heterogeneous households under incomplete markets. Shocks that increase global demand for critical goods lead to underinvestment relative to an economy with a representative household or complete markets. Trade exacerbates the shock as producers reallocate domestic sales toward exports. Shortages can be mitigated, increasing welfare, by taxing exports while subsidizing imports and production. These policy changes are consistent with cross-country evidence following recent shocks.