Optimal Tariffs with Firm Heterogeneity, Variable Markups, and FDI

Ziran Ding

No 99, Bank of Lithuania Working Paper Series from Bank of Lithuania

Abstract: Variable markups and multinational production have gathered considerable attention in the trade literature because of their empirical prevalence and welfare implications. This paper studies the welfare implication of tariffs and optimal tariffs in an environment that features firm heterogeneity, variable markups, and FDI. I find: (i) Tariffs endogenously affect firm entry level, producing different comparative statics in the short run versus long-run. (ii) Variable markups generate multiple externalities in this economy, causing market outcome to differ from the socially optimum outcome systematically. Permitting tariff-jumping FDI can lower the domestic cutoff levels and reduce the misallocation in the economy. (iii) Free trade is not always socially optimal. If the domestic marginal cost cutoff is sufficiently high, a positive tariff can be welfare-improving since it encourages firm entry. The Nash equilibrium tariff level will also be higher than the socially optimal tariff. (iv) The interaction of variable markup and FDI generates novel welfare implications that are absent if consumers possess CES preference.

Keywords: Optimal tariff; Firm heterogeneity; Misallocation; Variable markups; FDI (search for similar items in EconPapers)
JEL-codes: F12 F13 F23 F60 R13 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2021-12-31
New Economics Papers: this item is included in nep-int
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