Welfare-maximizing tariff versus trade-surplus-maximizing tariff: Impacts on multinational firm competition

Abstract

Designing appropriate import tariff rates is crucial for global trade. In this paper, we propose game-theoretic models to investigate how tariff policies affect the competition of multinational firms (MNFs) in a global trading environment. The MNFs sell substitutable products and compete in two countries where the governments may adopt a welfare-maximizing tariff or a trade-surplus-maximizing tariff. We derive the equilibrium outcomes under different tariff policies and analyze the effects on the MNFs' profits and social welfare. We find that the MNF will solely serve the domestic market if the foreign country's tariff rate exceeds a threshold. We show that the tariff rate is higher under the trade-surplus-maximizing tariff than under the welfare-maximizing tariff. Under the welfare-maximizing tariff, the government may set a modest tariff rate to incentivize the product sales by the foreign MNF if its product's value-added level (i.e., the product value deducting the production cost) is high relative to the domestic MNF's. However, under a trade-surplus-maximizing tariff policy, the government always sets a high tariff rate to block imports. Moreover, we find that if one government deviates from the welfare-maximizing tariff to the trade-surplus-maximizing tariff, this always hurts social welfare and also harms the domestic MNF's profit if its product value-added level is low relative to the foreign MNF's. If the other government responds by switching to the trade-surplus-maximizing tariff as well, this will benefit the domestic MNF but harm social welfare.