Lerner meets metzler : tariff pass-through of worldwide trade

In this paper, we start with quantifying the worldwide tariff pass-through, i.e., the impact of tariff reductions on trade prices. We find that a 1% reduction of tariffs decreases trade prices by 0.1%, i.e., a negative tariff pass-through (Lerner paradox). To uncover the mechanism underlying this result, we decompose trade prices into product quality and quality-adjusted trade prices. As a result, we found that a 1% reduction of tariff rates decreases product quality by 1.2% and increases quality-adjusted trade prices by 1.1% (Metzler paradox). We construct a theoretical model that demonstrates the mechanism behind these empirical results. We suggest that both a firm-delocation mechanism under variable markups and a quality-sorting mechanism are the driving forces behind these empirical findings. Lastly, by employing this theoretical model, we also examine the welfare effect of tariff changes.