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A second-best argument for low optimal tariffs on intermediate inputs

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  • Caliendo, Lorenzo
  • Feenstra, Robert C.
  • Romalis, John
  • Taylor, Alan M.

Abstract

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, roundabout production and the monopoly distortion in the traded sector create strong incentives to lower the optimal tariff on imported inputs. In a quantitative version of our two-sector small open economy, we find that the optimal tariff is lowered under nearly all parameter values considered, and can be negative.

Suggested Citation

  • Caliendo, Lorenzo & Feenstra, Robert C. & Romalis, John & Taylor, Alan M., 2023. "A second-best argument for low optimal tariffs on intermediate inputs," Journal of International Economics, Elsevier, vol. 145(C).
    • Handle: RePEc:eee:inecon:v:145:y:2023:i:c:s0022199623001101
    DOI: 10.1016/j.jinteco.2023.103824
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    Cited by:

    1. Pau Pujolas & Jack Rossbach, 2024. "Trade Wars with Trade Deficits," Papers 2411.15092, arXiv.org, revised Dec 2024.
    2. Caliendo, Lorenzo & Feenstra, Robert C., 2024. "Foundation of the small open economy model with product differentiation," Journal of International Economics, Elsevier, vol. 150(C).
    3. Pau S. Pujolas & Jack Rossbach, 2024. "Trade Wars with Trade Deficits," Department of Economics Working Papers 2024-09, McMaster University.

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    More about this item

    Keywords

    Trade policy; Monopolistic competition; Gains from trade; Input–output linkages;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F17 - International Economics - - Trade - - - Trade Forecasting and Simulation
    • F61 - International Economics - - Economic Impacts of Globalization - - - Microeconomic Impacts

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