Reassessing trade barriers with global production networks

Abstract

This paper develops a two-country general equilibrium model with forward-looking participation decisions on exporting and multinational production, and examines the effects of final-goods tariffs and intermediate-input tariffs. I show that permanent unilateral tariffs lead to a recession in the policy-imposed country. In the policy-imposing country, investment experiences a short-run boom while consumption falls immediately and persistently, with intermediate-input tariffs resulting in a larger contraction. At the firm level, the least productive exporters exit from the policy-imposing country, while the most productive ones relocate production there. Relative to a model without multinational firms, this production relocation partially offsets the contractionary effects of tariffs. Crucial to the short-run investment expansion and firms' participation in multinational production in the policy-imposing country is the persistence of tariffs. When tariffs are temporary, investment falls immediately, driving an immediate recession there, in contrast to permanent tariffs. Further, temporary tariffs induce hysteresis in firms' participation in exporting and multinational production, which in turn diminishes the expansionary effects of multinational entry.