Tariff Reductions, Entry, and Welfare

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1 Tariff Reductions, Entry, and Welfare Theory and Evidence for the Last Two Decades Lorenzo Caliendo Yale University, NBER John Romalis University of Sydney, NBER Robert C. Feenstra UC. Davis, NBER Alan M. Taylor UC. Davis, NBER January 2018 Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

2 Introduction There has been an unprecedented reduction in bilateral and multilateral trade tariffs over the last quarter century Uruguay Round (Most-Favoured-Nation -MFN tariffs) and PTA s (Preferential Trade Agreements) led to reductions in the level and dispersion of tariffs Yet, very little it is known about the quantitative effects of these actual tariff changes Requires comprehensive commercial policy dataset In particular, the role that firm entry and production linkages play in shaping the effects from tariff changes Requires extending quantitative trade policy frameworks Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

3 What is this paper about? Theory: We build on recent advances in trade and present a quantitative heterogeneous firms model for tariff policy evaluation Multiple-country, multiple-sectors, intermediate goods and I-O linkages Importantly, commercial policy influences entry of firms within sectors Quantitative evaluation of Uruguay Round and PTA tariffs cuts: Many different tariff sources (e.g. TRAINS), including hand collection from the International Customs Tariffs Bureau (BITD) Annual (T = 28); World (M = 189 countries); SITC 4-digit Major tariff reductions in advanced & emerging/developing Bigger in the latter countries, and the real action starts circa 1990 Merge with global IO tables (EORA) with 15 industries Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

4 Our results We show and quantify how tariff policy affects the entry margin Obtain analytical solutions in a two-sector, two-country model, and show conditions under which the optimal unilateral import tariff is negative Result crucially depends on the level of openness and production linkages We find that Uruguay Round generated larger trade and welfare effects than PTA s Moving to Free-trade, Emerging/Developing countries gain more Investigate the potential for negative optimal tariffs in the general quantitative model, which hold for about one-quarter of the countries Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

5 Road map Model Quantitative multi-country model Illustrative Two-Sector, Two-Country Model Tariff data Quantification of the trade and welfare effects of the Uruguay round and PTA s Conclusion Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

6 The Model M countries, indexed by i and j, and S sectors indexed by s and s There is a mass L i of identical agents in each country Supply labor, consume final goods with share α s, S s=1 α s = 1 Sectoral outputs are nontraded and produced with intermediate varieties from the same sector Q i,s = [ (Q ) ωs 1 H ωs i,s + ( ωs 1 ] Qi,s F ) ωs ωs ωs 1 Q H i,s is a CES aggregator over domestic varieties, elasticity σ s > 1 Q F i,s is a CES aggregator over foreign varieties, elasticity σ s > 1 CES Sectoral outputs "finished goods" are used as materials, i.e. inputs, for the production of intermediate goods Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

7 The Model Intermediates produced in each sector under monopolistic competition with heterogeneous productivities ϕ Producers demand labor (γ i,s ) and materials from all sectors (γ i,s s ) Materials means domestic finished goods from own sector and other sectors (I-O) Caliendo and Parro (2015) q i,s (ϕ) = ϕl i,s (ϕ) γ i,s S m i,s s (ϕ) γ i,s s, s =1 Free entry, fix entry cost fi,s E Upon entry, ϕ is drawn from distribution G s (ϕ) We assume that G s (ϕ) = 1 ϕ θ s with θ s > σ s 1 Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

8 Production of Intermediates Ad valorem tariff t ij,s applied to the revenue of imports from i to j Iceberg trade costs τ ij,s 1 with τ ii,s = 1 Firms face fixed fixed costs of exporting, f ii,s f ij,s for all j = i,paid in domestic labor Profits π ij,s (ϕ) = { pij,s (ϕ) max q ij,s (ϕ) x } i,s p ij,s (ϕ) t ij,s ϕ τ ij,sq ij,s (ϕ) w i f ij,s where x i,s (w i ) γ i,s S s =1 (P i,s ) γ i,s s Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

9 Selection and Free Entry Selection (ZCP) Denote by ϕij,s to the cutoff or threshold productivity if ϕ < ϕij,s then firm is not active in country j Free Entry (FE) Denote by N j,s the mass of entering firms to j in sector s The number of firms/products actually sold in sector s, from country j, into market i is given by N j,s [1 G s (ϕ ji,s )] = N j,s ϕ ji,s θ s Free Entry (FE),with w i 1, L i = S ( ) N i,s fi,s E θs σ s. s=1 σ s 1 Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

10 Illustrative Two-Sector, Two-Country Model Adopt the simplest model that illustrates outcomes as trade costs vary Consider a two-country, two-sector model Each country has a mass L agents, wlog w H = 1 Sector 1: monop. comp., traded inputs + labor Sector 2: perf. comp., no inputs, labor (no traded inputs) Consumption share of tradable given by α Ad valorem home tariff t FH = t > 0, iceberg costs τ ij = τ Fixed costs f X f D, f E in sector 1 (zero in sector 2) Share of materials in production, γ γ i,ss with 0 < γ < 1 Define γ σ 1 σ α γ γ, 1 γ 1, κ σ 1 θ > 1, κ >< 1. Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

11 Change in Welfare in the 2x2 Model du H U H α = t=0 (1 γ)θ dλ HH λ HH } {{ } trade volume α(1 λ) + (κ 1) dt + (1 γ)θ }{{} entry+selection α(1 λ) (1 γ) dt. } {{ } tariff rebate Theorem Iff ( ) σ 1 γ γ σ ( > 1 2 α σ + 1 [(σ 1)/θ] a small increase in the tariff t is worse than an increase in iceberg transport costs, namely d ln U H < α (1 γ)θ d ln λ HH. This condition holds only if γ > 0 (production linkages are present) and α < 1 (the service sector is present). ), Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

12 Welfare Iceberg versus Tariffs Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

13 Welfare Iceberg versus Tariffs (Role of Production linkages) Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

14 Small change in the Home tariff only around FTE Theorem (a) γ = 0 (no linkages): close to unity (remoteness); d ln U H dt (b) γ 1 (strong linkages): γ=t=0 < 0 if α < 1 and λ is suffi ciently d ln U H dt t=0,limγ 1 < 0 for all 0.5 < λ < 1 and α 1. It follows in either case that the optimal home tariff is negative. Bottom line: Countries with more production linkages benefit more from lower tariffs Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

15 Bring New Tariff Data to Table Look at the raw MFN tariffs About 1m obs per year in 1980s, rising to 2m by 2000s! Can see that both MFN and preferential tariffs fell, by about the same amount (7 pct.pt.: note that) Ad valorem tariff (%) MFN tariffs, mean Preferential tariffs, mean Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

16 Tariff policy variation By region and year Remark: big declines in levels and dispersion in Em./Dev. Percentiles marked are 5/10/25/50(red)/75/90/ All countries Advanced Emerging/Developing Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

17 Quantitative Model - taking the model to the data Use 1990 EORA dataset ( Input-Output Matrix Data put to use for many countries 189 countries, 15 sectors, with national input-output tables Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

18 Tariff policy variation - sectors By sector and year Remark: big declines in most sectors All Agriculture and Fishing : 01 Mining and Quarrying : 02 Food & Beverages : 03 Textiles and Wearing Apparel : 04 Wood and Paper : 05 Petro., Chem. and Non-Met. Minerals : 06 Metal Products : 07 Electrical and Machinery : 08 Transport Equipment : 09 Other Manufacturing and Recycling : Trade-weighted tariff (%) in sector s, averaged over pairs ij, by type of importer Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

19 Tariff policy variation - sectors By Region, Sector, and Year Remark: big declines in Em./Dev. all sectors Advanced Emerging/Developing t = aggregate trade-weighted tariff (%), average over pairs ij, in sector s Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

20 Quantitative Model - taking the model to the data Calibrate the model to assess the gains from tariff changes In principle we need information on fixed costs: f ij,s and fi,s E for all i, j, s But compute the model in changes (hat notation ŷ = y /y) hat M + 4SM + SM 2 = equations and unknowns Need estimates of θ s, σ s, and ω s θ Eaton, Kortum, and Kramarz (2008): s σ s Caliendo and Parro (2015) sectoral elasticities: σ s θ s σ s 1 1 Back out θ s and σ s, but lower in services (Gervais and Jensen, 2013). Sectors σ s θ s σ s 1 1 θ s σ s Agriculture and Fishing (1 sector) Mining and Quarrying (1 sector) Manufacturing Sectors (all 8 sectors) Nontraded services (all 5 sectors) Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

21 Four Policy Experiments Baseline levels 1990 actual = min(preference 1990, MFN 1990) Uruguay Round only min(preference 1990, MFN 2010) Uruguay Round + Preference 2010 actual = min(preference 2010, MFN 2010) Free Trade = set all tariffs to zero Negative (optimal) Tariffs = check country-by-country Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

22 Welfare gains from actual tari changes Years , percentage change Caliendo, Feenstra, Romalis, Taylor Tari Reductions, () Entry, and Welfare January / 28

23 Welfare gains from 2010 tari s to Free trade Percentage change Caliendo, Feenstra, Romalis, Taylor Tari Reductions, () Entry, and Welfare January / 28

24 Negative Optimal Tariffs Due to Strong Linkages (Theorem part (b)): Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

25 Negative Optimal Tariffs Due to Strong Linkages (Theorem part (b)): Belgium, France, Italy, Luxembourg, Portugal, Sweden, and also Malaysia and the Philippines (with Hungary on the borderline with a zero optimal tariff). Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

26 Negative Optimal Tariffs Due to Strong Linkages (Theorem part (b)): Belgium, France, Italy, Luxembourg, Portugal, Sweden, and also Malaysia and the Philippines (with Hungary on the borderline with a zero optimal tariff). Due to Remoteness (Theorem part (a)): Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

27 Negative Optimal Tariffs Due to Strong Linkages (Theorem part (b)): Belgium, France, Italy, Luxembourg, Portugal, Sweden, and also Malaysia and the Philippines (with Hungary on the borderline with a zero optimal tariff). Due to Remoteness (Theorem part (a)): Andorra, Angola, Aruba, Bahamas, Bahrain, Belarus, Belize, Brazil, British Virgin Islands, Brunei, Cameroon, Cayman Islands, Croatia, Cyprus, Czechia, Congo, Greenland, Haiti, Jamaica, Latvia, Liberia, Libya, Macao, Maldives, Mauritius, Moldova, Morocco, Namibia, Netherlands Antilles, New Caledonia, Palestine, Rwanda, San Marino, Sao Tome and Principe, Saudi Arabia, Slovenia, Syria and Yemen. Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

28 Negative Optimal Tariffs Due to Strong Linkages (Theorem part (b)): Belgium, France, Italy, Luxembourg, Portugal, Sweden, and also Malaysia and the Philippines (with Hungary on the borderline with a zero optimal tariff). Due to Remoteness (Theorem part (a)): Andorra, Angola, Aruba, Bahamas, Bahrain, Belarus, Belize, Brazil, British Virgin Islands, Brunei, Cameroon, Cayman Islands, Croatia, Cyprus, Czechia, Congo, Greenland, Haiti, Jamaica, Latvia, Liberia, Libya, Macao, Maldives, Mauritius, Moldova, Morocco, Namibia, Netherlands Antilles, New Caledonia, Palestine, Rwanda, San Marino, Sao Tome and Principe, Saudi Arabia, Slovenia, Syria and Yemen. It appears that (some of) the countries with largest welfare gains are benefitting from their own tariff cuts rather than RoW tariff cuts Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

29 Welfare Effects Most of the gains are due to MFN tariff reductions (Uruguay round) compared to PTA s The Uruguay round generated an average increase in world welfare of 1.43%, while the additional effect from PTAs was only 0.13% Welfare relative to 1990 baseline Welfare For individual countries, median, and 10 deciles (5-95), by trade policy BGD TWN NOR MDA ZMB BGD TWN NOR ZMB BGD MDA TWN MYS ZMB SUD NOR SGP SDS BHS BWA SUR COL BEN LAO IDN EGY VEN TTO 1990 Baseline Uruguay Round Uruguay Round + Preference Free Trade Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

30 Welfare: Advanced vs. Emerging/Developing Remark: Very heterogeneous welfare effects Advanced economies have less incentives to continue reducing tariffs compared to Emerging/Developing economies Welfare relative to 1990 baseline Welfare - Advanced For individual countries, median, and 10 deciles (5-95), by trade policy NOR 1990 Baseline Uruguay Round Uruguay Round + Preference Free Trade NOR NOR Welfare relative to 1990 baseline Welfare - Emerging/Developing For individual countries, median, and 10 deciles (5-95), by trade policy BGD BGD TWN MDA ZMB 1990 Baseline Uruguay Round Uruguay Round + Preference Free Trade BGD TWN ZMB BHS BWA MDA TWN MYS ZMB SUD SGP SDS SUR COL BEN LAO IDN EGY VEN TTO Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

31 Conclusion Tariff changes have major quantitative implications Affect entry decisions of firms across markets, sectors Almost all the gains from tariff elimination in the last two decades result from the MFN tariff cuts in the Uruguay Round Welfare gains are large, esp. for some EM/Dev countries Yet, very heterogeneous Production linkages play a very important role for commercial policy design Negative optimal tariffs Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

32 Finished good producer The cost minimization problem of the finished good producers in each sector s and country i is then M min {q ji,s N j,s (ϕ)} 0 j=1 ϕji,s p ji,s (ϕ) q ji,s (ϕ) g s (ϕ) d ϕ, subject to Q i,s = N i,s ϕ ii,s M N j,s j =i ϕji,s σs 1 q ii,s (ϕ) σs σs 1 q ji,s (ϕ) σs dg s (ϕ) dg s (ϕ) σs (ωs 1) ωs (σs 1) + σs (ωs 1) ωs (σs 1) ωs ωs 1 Back Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

33 Quantitative Model - relative changes Cost of the input bundle x i,s (ŵ i ) γ i,s S s =1 ( P i,s ) γi,s s Price index ( [ P i,s = M j=1 λ ji,s τ ji,s x j,s ] ) 1 θs θs (1 + tji,s ) Âji,s Trade shares Goods market Trade balance ˆλ ji,s = [ τ ji,s x j,s Y i,s = S s =1 γ i,ss σ s 1 σ s M j=1 S s=1 M j=1 θs (1 + tji,s )] Âji,s M j=1 λ ji,s [ τ ji,s x j,s (1 + tji,s )] θs Âji,s λ ji,s 1 + t ji,s λ ij,s 1 + t ij,s Y j,s + α ( i,s w Y i,s = S s=1 M j=1 λ ij,s 1 + t ij,s ( ) σs 1 θs ŵ where Â ji,s ˆN j (1+tji,s σs 1 ) j,s, and entry given by ˆN Ŷ i,s = i,s Back i L i + T i ) Y j,s, M λ ij,s j=1 1+t ij,s Y j,s ŵ i Caliendo, Feenstra, Romalis, Taylor Tariff Reductions, () Entry, and Welfare January / 28

Tariff Reductions, Entry, and Welfare

Tariff Reductions, Entry, and Welfare Theory and Evidence for the Last Two Decades Lorenzo Caliendo Yale University, NBER John Romalis University of Sydney, NBER Robert C. Feenstra UC. Davis, NBER Alan