Do Protective Tariffs Influence Firms’ Competitive Stance? Application of a Competitive Leverage Model in The Presence of Simultaneous Equation and Sample Selectivity Bias

Abstract

ABSTRACT:We propose a Competitive Leverage model, and apply it to analyze the impact of tariffs on the attitudes of domestic import-competing firms, especially regarding their disincentives to maintain a Competitive Stance against foreign competitors in the domestic market. We propose that tariffs are a disincentive to the pursuit and maintenance of production efficiency in firms and industries. When countries implement tariff protection for their domestic firms, the most common excuse sounds reasonable, except that it is also economically flawed. While the short-run impacts of such a measure might seem plausible, its long-term effects appear to be less than favorable, and may, in fact, turn out to be damaging to the economy. The paper applies the competitive leverage concept in a unique way to highlight how tariffs distort the output levels of domestic firms, and gives an empirical analysis of the model, using USA data to verify the predictions of the model. Particularly, we develop a Cournot-competition type Competitive Leverage model, and use it to examine the role played by tariffs as a disincentive to a typical firm’s pursuit and maintenance of production efficiency. The competitive leverage model is formulated and applied to verify the effects of tariff protection from the typical domestic firm’s strategic interaction standpoint. We further apply cross-sectional data to carry out an empirical analysis of the model, to verify how tariffs impact the domestic firm’s output and pricing decisions. Our findings would enable us to contribute to the debate about the need to remove protective tariffs, on the grounds that tariffs do not only enable domestic firms to operate inefficiently, but also tends to distort the output and pricing outcomes that would otherwise have been realized in the free market. The results from the study are used to propose some major policy implications of imposing tariff protection, among which are that there is need for implementation of more deliberately sustained Research and development program on the part of domestic firms in the economy, to enable them withstand vigorous competition in a free-trade world. Also, since protective tariffs significantly increase firms’ profit rates, which in turn enables them to unduly earn and accumulate economic rents that amount to inefficiencies and distortions in free-market prices and quantities outcomes, governments should always resist any pressures from big businesses to impose protective tariffs against competition from international rivals. Yet a clear public policy implication from this paper is that, at the macro level, as the results suggest that a government policy that aims at protecting domestic firms through imposition of tariffs may have an adverse effect on the firms’ competitive stance in the industry, a practical message is for the government to impose only a moderate tariff at the most, if it must, especially as it relates to agricultural products.