MODELING INTERNATIONAL TRADE UNDER THE THREAT OF TARIFF HIKES IN GENERAL EQUILIBRIUM

Abstract

There is mounting evidence that an important element in explaining the impact of trade policy on trade patterns and the behavior of firms is the role of policy uncertainty in shaping this behavior. In a setup where firms must incur a fixed cost to export, uncertainty over future profits will decrease the incentive of firms to enter into the export market. While uncertainty over any number of factors playing into export decisions (such as demand, productivity, exchange rate, etc.) may affect exporters' incentives to export, I focus here on trade policy uncertainty, specifically tariff rates, as this allows me to quantify the impact of one particular type of policy uncertainty, and can provide insight into the effects of broader policy uncertainty. Unlike most other forms of uncertainty, it is something that can be measured empirically using tariff rates. Further, understanding the effects of uncertainty over future tariff levels is important in its own right, as there is debate over whether trade agreements that do not substantially change applied tariff rates are of any value to exporters. My dissertation will address this question, arguing that there is indeed additional value to some trade agreements beyond that simply obtained by liberalizing tariffs: namely, that there is value in reducing uncertainty over future trade policy. In order to try to quantify this additional value, I develop a general equilibrium framework consistent with the types of Computable General Equilibrium (CGE) models that are often used to evaluate the potential value of proposed trade agreements, where my model takes into account this additional uncertainty-reducing benefit of entering into a trade agreement.

Chapter 1 introduces the topic and discusses broader implications of studying tariff uncertainty. In order to motivate the inclusion of tariff uncertainty in a general equilibrium framework, I begin in Chapter 2 by presenting empirical evidence, based on a partial equilibrium framework, of a negative impact of future tariff uncertainty on exports. In this chapter, I extend previous empirical analysis of tariff uncertainty (via tariff bindings) to a large set of countries and find a negative significant effect of policy uncertainty arising from binding overhang, and that this effect is heterogeneous across importing countries. On average, I find that the ad valorem tariff equivalent imposed by uncertainty arising from binding overhang for the set of countries in my sample is 8.2%.

In Chapter 3, I extend the theoretical analysis of tariff uncertainty in general equilibrium to a setting with endogenous entry not only into exporting but also into production with multiple countries and sectors. Based on this model, I obtain numerical results for the impacts of an (exogenous) threat of reverting to a permanent non-cooperative tariff level. In a symmetric two-country setting, the effects are a 4.55% reduction in trade and a 0.02% reduction in welfare. I am further able to derive the effect of a tariff threat on third-countries and outside sectors not directly targeted, and find these effects to be small.

In Chapter 4, I use the model developed in Chapter [chap:DSGE] to analyze the trade and welfare impacts of a particular agreement: the Chile-US Free Trade Agreement (FTA). This extends and complements econometric analysis of the impact of uncertainty in the context of other FTAs. I find that a model without the tariff threat effect predicts that Chilean exports to the United States should increase by 5.78% and number of exporting firms should increase by 2.80% as a result of the FTA, while the model with the effect of a tariff threat predicts that exports should increase by 6.98% and the number of exporters by 7.43%.