DP15697 A Second-best Argument for Low Optimal Tariffs

Author(s): Lorenzo Caliendo, Robert Feenstra, John Romalis, Alan M. Taylor
Publication Date: January 2021
Keyword(s): Gains from trade, input-output linkages, monopolistic competition, trade policy
JEL(s): F12, F13, F17, F61
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15697

We derive a new formula for the optimal uniform tariff in a small-country, heterogeneous-firm model with roundabout production and a nontraded good. Tariffs are applied on imported intermediate inputs. First-best policy requires that markups on domestic intermediate inputs are offset by subsidies. In a second-best setting where such subsidies are not used, the double- marginalization of domestic markups creates a strong incentive to lower the optimal tariff on imported inputs. In a 186-country quantitative model, the median optimal tariff is 10%, and negative for five countries, as compared to 27% in manufacturing from the one-sector, optimal tariff formula without roundabout production.