Glenn Magerman (Université Libre de Bruxelles)

We develop a quantitative general equilibrium framework to analyze optimal policy design in economic unions. The model features multiple locations and sectors connected through input-output linkages, monopolistic competition with external economies of scale, and love of variety across both source locations and product varieties. There are local and supranational governments, each with their own budgets to implement a toolbox of trade, industrial, and public policies. We derive analytical welfare decompositions at both the location and union levels. Three key results characterize the roles of standalone optimal policies. First, trade policy implies free trade as common external tariff requirements prevent exploiting location-specific comparative advantages. Second, industrial policy exploits input-output linkages to correct misallocation by subsidizing upstream industries, propagating benefits downstream, enabling taxation of downstream sectors. Third, public policy concentrates expenditures in sectors with high economies of scale, but cannot effectively correct misallocation. Optimal policy design combines all three instruments: trade policy extracts terms-of-trade rents through positive tariffs, industrial policy targets upstream misallocation, and government expenditure smooths locational disparities arising from the incidence of the other policies. We illustrate the framework using data on 235 EU regions and the rest of the world across 54 sectors. The optimal policy mix delivers aggregate welfare gains of 12.9% relative to laissez-faire, substantially exceeding the sum of standalone policies, demonstrating strong complementarities across instruments.