Lerner meets Metzler: Tariff pass-through of worldwide trade

Abstract

In this study, we quantify the worldwide tariff pass-through, that is, the impact of tariff reductions on trade prices. Some estimations show that a one-percentage-point reduction in tariffs decreases trade prices by approximately 0.1% (Lerner paradox). To determine the mechanism underlying this result, we decompose trade prices into product quality and quality-adjusted trade prices. We find that a one-percentage-point reduction in tariff rates decreases product quality by approximately 1.6% and increases quality-adjusted trade prices by approximately 1.5% (Metzler-like paradox in terms of quality-adjusted price). Thus, we construct a theoretical model to demonstrate the mechanism behind these empirical results. We suggest that both a firm-delocation mechanism under variable markups and a quality-sorting mechanism are the driving forces behind these empirical findings. Finally, we examine the welfare effect of tariff changes by employing this theoretical model. Despite the large decrease in trade prices, trade liberalization worsens consumer welfare.