A larger country sets a lower optimal tariff

• Published date: 01 May 2019
• DOI: http://doi.org/10.1111/roie.12391
• Author: Takumi Naito
• Date: 01 May 2019

Rev Int Econ. 2019;27:643–665.

|

643wileyonlinelibrary.com/journal/roie

1

|

INTRODUCTION

It is widely believed among trade economists that an optimal tariff for a large country is positive, and

that a larger country sets a higher optimal tariff. Based on two‐country, two‐good trade models, Kennan

and Riezman (1988) and Syropoulos (2002) verify the latter statement, and even show that a sufficiently

larger country can win a tariff war in that its welfare under the Nash equilibrium of a tariff setting game

is higher than under the global free trade.1 More recently, the optimal tariff problem is reconsidered

in the Dornbusch–Fischer–Samuelson (1977) (DFS henceforth) Ricardian model with a continuum of

goods: Opp (2010) and Costinot, Donaldson, Vogel, and Werning (2015) confirm that the optimal tariffs

are positive and uniform across imported goods, provided that export taxes are unavailable. Moreover,

Opp (2010) demonstrates that a country’s uniform optimal tariff is increasing in its productivity adjusted

size including its absolute advantage parameter and labor endowment. This tempts us to conclude that

the beginning two statements are theoretically robust in a wide class of models.2

Received: 16 November 2017

|

Revised: 27 November 2018

|

Accepted: 20 December 2018

DOI: 10.1111/roie.12391

ORIGINAL ARTICLE

A larger country sets a lower optimal tariff

TakumiNaito

Faculty of Political Science and

Economics,Waseda University, Tokyo,

Japan

Correspondence

Takumi Naito, Faculty of Political Science

and Economics, Waseda University,

1‐6‐1 Nishiwaseda, Shinjuku‐ku, Tokyo

169‐8050, Japan.

Email: tnaito@waseda.jp

Funding information

I acknowledge Japan Society for the

Promotion of Science (#25380336) and

Research Institute of Economy, Trade and

Industry for financial support

Abstract

We develop a new optimal tariff theory that is consistent

with the fact that a larger country sets a lower tariff. In our

dynamic Dornbusch–Fischer–Samuelson Ricardian model,

the long‐run welfare effects of a rise in a country’s tariff

consist of the direct revenue, indirect revenue, and growth

effects. Based on this welfare decomposition, we obtain two

main results. First, the optimal tariff of a country is positive.

Second, the optimal tariff of a country is likely to be de-

creasing in its absolute advantage parameter, implying that

a larger (i.e., more technologically advanced) country sets a

lower optimal tariff.

JEL CLASSIFICATION

F13, F43

This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits use and

distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or adaptations are

made.

© 2019 The Authors Review of International Economics Published by John Wiley & Sons Ltd

644

|

NAITO

In fact, things go the other way. Figure 1 gives a scatter plot of countries’ tariff rates (applied, simple

mean, all products [%]) against the natural log of GDP (PPP, constant 2011 international dollars), both on

five 5‐year averages from 1991 to 2015 (N = 749, Source: World Development Indicators). The red re-

gression line indicates a significant negative relationship between log GDP and the mean tariff: a pooled

OLS gives the slope of –0.680 (robust standard error: 0.126), implying that an increase in log GDP by one

unit (i.e., an increase in GDP by 2.718 times) tends to decrease the mean tariff by 0.680%. Furthermore,

breaking down log GDP into log GDP per capita and log population, the former has a more negative and

significant slope of –2.896 (robust standard error: 0.205), whereas the latter loses its significance (slope:

0.00124; robust standard error: 0.166). These results are robust even if GDP in constant 2010 U.S. dollars

is used instead of GDP in PPP.3 This means that an economically larger country (in terms of GDP per

capita rather than population) tends to set a lower tariff in contrast to the existing optimal tariff theory.

Broda, Limão, and Weinstein (2008) try to resolve this puzzle from an empirical perspective by

using data on highly disaggregated (i.e., four‐digit Harmonized System) product categories for 15

countries that set their tariffs freely before joining the WTO from the 1990s to the early 2000s. They

find that the actual tariffs follow the optimal tariff formula, that is, tariffs are higher for products

whose estimated inverse export supply elasticities are large. However, they do not report direct evi-

dence that countries with larger GDP tend to set higher tariffs as the existing theory suggests. How can

we explain the fact that a larger country sets a lower tariff?4 The purpose of this paper is to develop a

new optimal tariff theory that is consistent with the data.

We depart from the DFS Ricardian optimal tariff model of Opp (2010) in one respect: eco-

nomic growth. Empirical research around 2010 (e.g., Estevadeordal & Taylor, 2013; Wacziarg &

Welch, 2008) shows that trade liberalization does indeed raise economic growth, thereby overcoming

Rodriguez and Rodrik’s (2000) concern for robustness. If this is true, then a welfare‐maximizing

country may be less willing to set a high tariff. To address this point, we incorporate import tariffs into

the framework developed by Naito (2012), who combines the multi‐country AK endogenous growth

model of Acemoglu and Ventura (2002) with the DFS Ricardian model to study the dynamic effects of

changes in iceberg trade costs. By doing this, we can derive a country’s dynamic optimal tariff, which

is directly comparable with its static version corresponding to Opp (2010).

FIGURE 1 Log of GDP PPP and tariff rate

Source. World Development Indicators [Colour figure can be viewed at wileyonlinelibrary.com]