Tariff Cuts Research Articles

Preferential trade liberalization with endogenous cartel discipline: Implications for trade and welfare

AbstractWe consider an international cartel whose members interact repeatedly in their own as well as in third‐country markets. Cartel discipline—an inverse measure of the degree of competition between firms—is endogenously determined by the cartel's incentive compatibility constraint, which strategically links markets that are otherwise independent. This linkage implies that trade cost reductions induce cartel members to adjust their sales, not only because of direct but also because of spillover effects. We apply these ideas to preferential trade agreements and show that the indirect effects can give rise to trade diversion. We also characterize the welfare effects of preferential tariff cuts for all countries and identify circumstances under which preferential trade liberalization is welfare‐reducing.

Weather shocks affect trade policy: Evidence from preferential trade agreements

AbstractWe show that weather shocks affect government trade policy decisions. We exploit variation in rainfall during the growing season within and across countries to show that weather shocks impact agricultural output and trade. Using information on tariff cuts by commodity from preferential trade agreements signed between 1995 and 2014, we then show that weather shocks that happen during the negotiation period correlate strongly with the size of tariff cuts. When weather shocks increase (decrease) a country's capacity to produce a given crop, its government negotiates a smaller (larger) tariff cut. These results are consistent with a political economy trade model with sector‐specific inputs in which the government places more weight on producers relative to consumers in its objective function. They also reveal that governments update their beliefs about domestic agricultural production capacity in response to weather shocks.

CEO turnovers as organizational responses to shocks in competition

This paper provides novel evidence of organizational responses in the form of CEO turnover to competition shocks induced by unexpected tariff cuts. We find that the likelihood of CEO turnover increases with unexpected surge in industry competitiveness, and this result is mainly driven by non-exporting firms. Among non-exporting firms, the higher likelihood of CEO turnover is confined to firms with weak governance, high leverage, and in financial distress. Exporting firms, on the other hand, experience increased exports and show no significant CEO turnover changes.

When are tariff cuts not enough? Heterogeneous effects of trade preferences for the least developed countries

Poor countries export a remarkably narrow range of products. To what extent have trade preferences targeted to the least developed countries (LDCs) changed this situation? We study a large set of recent reforms to the LDC trade preferences offered by OECD countries. Leveraging trade policy variation by importer, exporter, product and year, we show that tariff reductions have increased the prevalence of positive trade flows. However, new flows have been far more likely to emerge in cases with previous ‘export experience’, i.e. where countries already exported the same product to another OECD country, or exported a related product to the same importer. So this wave of tariff cuts for LDCs has resulted in an extension of existing patterns of trade rather than wider export diversification.

The pro-competitive effects of trade agreements

How does trade policy affect competition? Using the universe of product exports by firms from eleven low and middle income countries, we document that tariff reductions under trade agreements have strong pro-competitive effects — they encourage entry and reduce the (tariff exclusive) price-cost markups of exporters. This finding, that markups fall with tariff cuts, contradicts a core prediction of standard oligopolistic competition models of trade. We extend a workhorse international pricing model of oligopolistic competition to include multiple countries and a rich preference structure. Our preference structure allows for fierce competition among firms from the same country and less intense competition among firms from different countries. We show a firm’s optimal markup after a tariff cut can rise or fall depending on the parameters of the preference structure and tariff-induced reallocation of market share among firms and across countries.

Labor Unions and the Electoral Consequences of Trade Liberalization

Abstract We show that the Brazilian trade liberalization in the early 1990s led to a permanent relative decline in the vote share of left-wing presidential candidates in the regions more affected by the tariff cuts. This happened even though the shock, implemented by a right-wing party, induced a contraction in manufacturing and formal employment in the more affected regions, and despite the left’s identification with protectionist policies. To rationalize this response, we consider a new institutional channel for the political effects of trade shocks: the weakening of labor unions. We provide support for this mechanism in two steps. First, we show that union presence—proxied by the number of workers directly employed by unions, by union density, and by the number of union establishments—declined in regions that became more exposed to foreign competition. Second, we show that the negative effect of tariff reductions on the votes for the left was driven exclusively by political parties with historical links to unions. Furthermore, the impact of the trade liberalization on the vote share of these parties was significant only in regions that had unions operating before the reform. These findings are consistent with the hypothesis that tariff cuts reduced the vote share of the left partly through the weakening of labor unions. This institutional channel is fundamentally different from the individual-level responses, motivated by economic or identity concerns, that have been considered in the literature.

Trade liberalisation and off-farm employment of the rural labour force: Evidence from China’s WTO accession

This paper investigates the impact of trade liberalisation on the rural labour force in China, with a particular focus on labour mobility and off-farm employment. The analysis utilises micro data from the National Fixed Point Survey and Chinese manufacturing firms. The identification strategy relies on combining information on the initial province labour and product market structure with the exogenous tariff reduction schedule over WTO accession and distinguishes between output markets and intermediate input tariffs. The results are as follows: First, the reduction of output tariffs does not promote rural labour mobility, whereas the reduction of input tariffs has a positive impact on mobility. Additionally, output tariffs reduce off-farm employment income and time, while input tariffs increase them. This conclusion is applicable only to low-skilled labour. Second, the tariff reduction significantly affects total wages and the number of employees in firms, as supported by macro data. This suggests that tariff cuts have implications for firm employment and, consequently, rural employment. Third, tariff cuts have a more pronounced effect on young individuals, those with lower levels of education, and the female workforce. Therefore, the interests of these groups should be fully considered in the process of further import liberalisation and tariff reduction.

Trade Liberalization, IMF Conditionality, and Policy Substitution in Developing Countries

AbstractSubstantial tariff reductions and increased usage of non‐tariff measures (NTMs) have been key dynamics of global trade policy in recent decades. We use highly disaggregated data on applied most favored nation tariffs, NTMs, and trade to investigate how International Monetary Fund (IMF) conditionality as a form of external pressure to reduce tariffs contributed to this dynamic in developing countries. Our results show that structural adjustment programs (SAPs) effectively lowered tariffs without increasing the usage of NTMs. A typical three‐year program containing tariff conditionality decreased tariff rates in the range of 2.0 to 3.8 percentage points in total. Furthermore, IMF programs reduced NTM initializations significantly. We also show that tariff conditionality was more effective in initiating tariff cuts for countries without previous greater globalization efforts than being a “catalyst” for ongoing liberalization efforts.

Board cultural diversity and firm performance under competitive pressures

AbstractWe examine the impact of board cultural diversity, based on directors' ancestry, on firm performance conditional on product market competition. We argue that culturally diverse boards foster critical thinking and offer creative solutions that help firms thrive in competitive environments. We document that culturally diverse boards are associated with superior performance for firms operating in highly competitive industries. To address potential endogeneity issues, we use a quasi‐natural experiment of the U.S. import tariff cuts. The positive impact of board cultural diversity on firm performance in competitive markets manifests itself in firms that innovate more, require creative inputs, and face heightened predation risk due to their high interdependence with industry rivals, in line with culturally diverse boards effectively performing their advisory role. Lastly, we find no evidence that board cultural diversity is associated with enhanced monitoring as its benefits fade in the presence of powerful CEOs.

The Limits of Liberalization: WTO Entry and Chinese State-Owned Firms

Abstract Does state ownership limit the liberalizing effects of the WTO? We examine the case of China, which is not only the largest exporting state but also lends active support to state-owned enterprises (SOEs) that could distort global trade. Using data on import purchases disaggregated by ownership from 1993 to 2012, we analyze how WTO entry affects the commercial orientation of state-owned and private imports. We demonstrate that after WTO entry, tariff cuts have a larger effect on private compared to SOE trade. We then show that state ownership alone does not block the WTO’s liberalizing effects. For most industries, SOEs and private firms are alike in their commercial orientation. However, where strategic goods targeted by industrial policy hold a large share of bilateral trade, lowering tariffs has no impact on SOE trade. These findings highlight the tensions between state-led economic models and global trade law premised upon market principles.

Pulling together by paying together: The effect of product market competition on TMT incentive dispersion

We examine whether firms that face increased competition are more likely to seek uniformity in the incentive payments made to top management teams (TMTs). Motivated by social comparison theory, we conjecture that variation in executive incentive payments will reduce as a strategic response to encourage TMT cooperation. We test this hypothesis by examining how TMT incentive dispersion changes following exogenous product market competition shocks from reduced tariff cuts. Matched difference-in-differences regressions on a large sample of manufacturing firms between 1992 and 2019 support our prediction. Firms experiencing large tariff cuts are associated with both lower total- and equity-incentive dispersion. This effect is stronger for firms with more powerful CEOs, suggesting that CEOs are a key channel for implementing the strategic use of TMT incentives in firms facing external competition.

Distributional Impacts of the Canada-US Free Trade Agreement

We examine the effects of the 1988 Canada-US Free Trade Agreement (FTA) on employment and earnings inequality among low-, medium-, and high-income Canadian workers initially employed in manufacturing. Although the FTA tariff cuts drove large changes in trade flows, we find generally small effects on employment and cumulative earnings during 1989-2004. Workers faced negative effects of import competition and positive effects of access to the US export market, but these effects were largely offset by transitions into other industries and sectors. The effect on earnings inequality was small, with point estimates implying a slight reduction in earnings inequality.

Energy price shocks and stabilization policies in the MATRIX model

The recent surge in energy prices in Europe has prompted governments to introduce policy measures to support households and businesses. This paper uses the MATRIX model, a multi-sector and multi-agent macroeconomic model calibrated on the Euro Area, to analyse the economic and distributional effects of different macro-stabilization policies in response to energy price shocks. We find that, without policies, a surge in fossil fuel prices leads to higher inflation, lower GDP, and slow recovery. Generalized tax cuts and household subsidies have no significant effects, while firm subsidies promote a faster recovery at the expense of financial instability in the medium term, leading to a second slump. However, this second-round effect can be mitigated with proper fiscal-monetary policy coordination. If timely adopted, a government-funded energy tariff reduction is the most effective policy in mitigating GDP losses at relatively low public costs, particularly when coupled with an extra-profit tax on energy firms. Energy entrepreneurs benefit from rising fuel prices in all scenarios, but workers and downstream firms’ owners benefit more from energy tariff cuts and windfall profits tax.

Deeper Integration or Open Regionalism in the Indian Ocean Rim Association (IORA): A CGE Approach

The Indian Ocean Rim Association (IORA) is a regional association based on the principle of open regionalism to promote liberalization through trade and investment facilitation. This study compares two main scenarios with the ingredients of a deeper regional integration compared to the IORA's present open regionalism status. Scenario I evaluates the effects of gradual tariff cuts on IORA, while Scenario II combines the impact of tariff cuts, non-tariff measures (NTM) reduction, and trade facilitation. A recent recursive dynamic model, called Global Trade Analysis Project recursive dynamic model (GTAP-RD), was used to understand the adjustment path. The result shows welfare gain for all IORA countries when a trade liberalization involving tariff cuts is complemented with NTM reduction and trade facilitation. In addition, the "NTM spillover" effect on some non-IORA members (the rest of Gulf Cooperation Council, the rest of Greater Arab Free Trade Agreement, and the United Kingdom) was observed. The results suggest that IORA has more to gain if it involves a deeper regional integration than the present form of open regionalism.

Trade Policy Implications of a Changing World: Tariffs and Market Power

ABSTRACT A major economic rationale for trade agreements is limiting mutually harmful terms-of-trade externalities. We analyse the impact of market power on tariff commitments of original and acceded WTO members. As countries grow, their market power in different sectors can change in unforeseen ways. To quantify the economic significance of our estimates, we compare actual and predicted tariff commitments under current market power. We find that tariff cuts required to reflect current economic conditions would amount to up to $26.4 billion – nearly 10% of global tariff costs. In the past, the GATT/WTO system has updated tariff commitments through periodic ‘rounds’, and our findings support the long-overdue revival of the WTO’s negotiation function.

Economic integration and food security – The case of the AfCFTA

The study assesses potential effects of the African Continental Free Trade Area (AfCFTA) on agri-food sectors and food security in Africa. It employs the global Computable General Equilibrium model MAGNET in an ex ante analysis. The analysis has high regional and sectoral detail, representing the wide variety of African economies and trade policy strategies.The AfCFTA lifts 1.0 million people from risk of hunger while increasing national incomes. The rise in food prices offsets the increase in household income in a few regions. Food production increases in total, but several regions reduce production while increasing imports. Non-tariff measure reductions have higher impact than tariff cuts. A group of countries could experience adverse food security effects due to the AfCFTA.

Customs Union, Wage Inequality and Welfare in General Equilibrium

The article attempts to consider the impact of a customs union formed between two small countries embedded in the global economy and trading in intermediates, in terms of a general equilibrium framework. It shows that with such a union both countries will gain, although there will be asymmetric effect on wage inequality. However, with higher capital stock the significance of the formation of customs union will be undermined. It also shows that perfect international capital mobility will lead to finite changes in the economy, shutting down the less capital intensive unskilled export sector in each country, which in turn makes the bilateral union irrelevant. Further tariff reduction will increase inequality in both countries. We have also considered the welfare effects of formation of customs union in the form of tariff cut and such a tariff reduction unequivocally improves welfare of the customs union irrespective of small country and large country assumptions, without any intra-union income transfer. JEL Codes: F02, F11, F55, F68

Foreign competition and CEO risk-incentive compensation

How do firms modify CEO risk-incentive compensation in response to increased foreign competition? Theoretically we show the answer is ambiguous: increased competition can result in firms either increasing or decreasing the CEO's risk-taking incentives. Empirically using a quasi-natural experiment, tariff cuts resulting from important trade deals, we find evidence that in response to increases in foreign competition firms adjust CEO risk-incentive compensation downwards – a result that is more pronounced for firms with less risk-averse CEOs. These findings suggest that more intense foreign competition results in managers voluntarily taking on more risk, and firms therefore reduce the convexity in managers' compensation.

Re-Evaluation of Free Trade Agreement: Changes in Global Value Chain and Regional Value Contents

Purpose – The purpose of this study is to evaluate the economic effects of FTAs using the concept of value-added exports. So far, the economic effects of FTAs have been dependent on decrease in import prices due to tariff cuts in importing countries, but the actual tariff reduction need to consider the value added of the exporting countries. Design/methodology – Value-added export refers to the added value created in the exporting country out of total exports. Among value-added exports, direct value-added export is interpreted as the Regional Value Contents (RVC), from which the economic effect of the FTA can be analyzed. A modified GTAP-VA model takes into account RVC in order to estimate accurate effects of FTAs. Findings – By the re-evaluation of the FTA based on the RVC, this paper makes it clear that the economic effects of the existing FTA methodology have the possibility of overestimation. In addition, as a new FTA with a strengthened Rules of Origin (ROO) is being initiated, a negative impact on international trade and GVC utilization may occur. Originality/value – This study introduces the concept of value-added export in analyzing the effects of FTAs. The new analysis methodology of this paper emphasizes the importance of value-added exports. Re-organization of GVCs would change regional trade agreements and empower ROO by weakening existing GVCs and transforming the value chain from global into regional scope.

Trade liberalization and wages: Evidence from the closer economic partnership arrangement between mainland China and Hong Kong

This paper studies the impact of tariff cuts on workers’ wages in a single labor market by examining the Closer Economic Partnership Arrangement (CEPA) trade liberalization, in which China unilaterally eliminated hundreds of tariffs on Hong Kong’s goods in 2004. Utilizing five Hong Kong censuses from 1996 to 2016, we find consistent result that a one-sided tariff concession leads to an increase in the monthly wage of affected workers, averaging between 5.75% and 6.84%. Moreover, we explore the possibility that the effects of exposure to CEPA may be heterogeneous along several dimensions. The workers who benefited the most were more educated, in higher-skilled occupations, Mandarin-speaking, near retirement, or just starting their careers. Surprisingly, we found no increase in employment in the treated industries. We conclude that tariff cuts’ wage impact and, hence, their impact on wage inequality, depend on the local labor market composition and structure.