Figure 4 - uploaded by Matthew Cole
Content may be subject to copyright.
Source publication
The majority of research to date investigating strategic tariffs in the presence of multinationals finds a knife-edge result where, in equilibrium, all foreign firms are either multinationals or exporters. Utilizing a model of heterogeneous firms, we find equilibria in which both pure exporters and multinationals coexist. We utilize this model to s...
Contexts in source publication
Context 1
... to the fixed cost function, Figure 4 shows the relationship between the Nash tariff and í µí¼ for two cases, one where FDI is an option for firms and one where it is not. In the no FDI case, the Nash tariff is falling in í µí¼. ...
Context 2
... the previous section we found that regardless of whether FDI occurs in equilibrium, Nash tariffs are inefficiently high relative to the world welfare maximizing tariffs. In addition, as illustrated in Figure 4, equilibrium tariffs can differ. Furthermore, even for given tariffs, since multinationals charge different prices than exporters, one would expect this to have an impact on the equilibrium mass of exporters and domestic firms. ...
Similar publications
We study the long-run spatial distribution of industry using a multi-regioncore–periphery model with quasi-linear log utility Pflüger (Reg Sci Urban Econ 34:565–573, 2004). We show that a distribution in which industry is evenly dispersedamong some of the regions, while the other regions have no industry, cannot be stable.A spatial distribution wher...
Citations
... Similarly, Chaney (2008) makes a small country assumption to ensure changes in transport and fixed costs have no significant impact on the general equilibrium. 7 In this paper, quasi-linear preferences prove useful beyond the sim-4 See also Eaton, Kortum, and Kramarz (2008) who use a Melitz-type model calibrated to a French data set, and Lawless and Whelan (2008) who explain trade flows for Irish owned firms. 5 The use of fixed cost heterogeneity results in all firms of the same "type" (either pure domestic or exporting) to charge the same price. ...
... 6 See also Becker (2009). 7 Chaney (2008) points out that relaxing this assumption would reinforce his results. ...
... Though this is certainly a nice feature of the model, it is beyond the scope of this particular paper. However, Cole and Davies (2009) use an extension of this model to incorporate the additional option for a firm to become a multinational. They find that a country's Nash tariff is higher than the global optimum (which is a subsidy) and that FDI mitigates this difference. ...
There has been great focus in the recent trade theory literature on the introduction of firm heterogeneity into trade models. This introduction has highlighted the importance of the entry/exit decision of firms in response to changes in trade barriers. However, it is typical in many of these models to use iceberg transport costs as a general form of trade barriers that can be interchangeable with ad valorem tariffs. I show that this is not always an appropriate conclusion. Specifically, I illustrate that profit for an exporter is more elastic in response to tariffs than iceberg transport costs, which has implications for total product variety. One such implication is the possibility for there to be an anti-variety effect associated with lower transport costs while there also being a pro-variety effect associated with lower tariffs.
... The goal of this paper is to compare these two effects in a model where imperfectly competitive firms differ in their productivities and where the number of firms is endogenous. This approach was popularized by Melitz (2003) and has been applied to a number of issues including optimal tariffs (Cole and Davies, 2009), subsidies for FDI (Chor, 2009), tax competition for FDI (Davies and Eckel, forthcoming), and payroll taxes with informal labor markets (Paz, 2009). Doing so has several advantages and yields additional insight into the impact a shift from tariffs towards VAT would have. ...
... These changes in the number of firms and their output then feed directly into welfare through three channels: the price consumers pay, the number of varieties available to them, and aggregate income. As noted by Cole and Davies (2009), more productive firms form a larger part of the consumer's consumption basket because their lower costs mean that they have lower prices. As a result, lowering tariffs benefits consumers because the price reduction on high-productivity imports outweighs the loss in the number of varieties. ...
... As by Keen (2008), one of the benefits of a revenue neutral shift is that it reduces distortions in the relative consumption of home and foreign products. In the context of heterogeneous firms, as discussed by Chor (2009) and Davies and Cole (2009), an additional benefit of tariff reduction is that trade liberalization is that it increases the availability of foreign varieties to the home market and shifts resources towards more productive firms (a selection effect). Here, the selection effect is strengthened by the corresponding VAT increase which drives away low-productivity informal firms from the market. ...
The debate over the use of tariffs or value added taxes in developing countries has focused on the difficulty of collecting
VAT from the informal sector. This paper contributes by considering this issue with heterogeneous firms and endogenous entry.
This yields two results. First, acut in the tariff reduces the size of the informal sector. Second, the imposition of VAT
need not increase the size of the informal sector. Turning to simulation results, we find that switching from a tariff to
a revenue-neutral VAT increases welfare, in part because of the selection effect generated by heterogeneous firms.
KeywordsValue added tax–Tariffs–Informal markets–Firm heterogeneity
We develop a general equilibrium model of international trade with heterogeneous firms that accounts for productivity spillovers transmitted by foreign exporters. Everything else equal, stronger spillovers increase welfare. We embed the model framework into a trade policy scenario where countries strategically set inter‐country variable trade costs for the trading partner. In the strategic Nash‐equilibrium policy, governments trade‐off welfare gains from protectionism and those that are due to spillovers from foreign exporters. The equilibrium degree of protectionism is decreasing in the strength of the spillover. Policy coordination induces welfare gains but these gains can be hump‐shaped in the spillover strength.
The debate about replacing tariffs with value-added tax (VAT) in developing countries has paid little attention to the role of VAT as an input tax on the informal sector and has overlooked the usefulness of changing the VAT threshold in a revenue-neutral switch from tariffs to VAT. This paper contributes to the literature by addressing these two issues via a heterogeneous firm model of a small open economy with endogenous firm entry and VAT compliance. The results found indicate that the VAT collected on intermediate inputs consumed by the informal sector not only reduces the benefits of evading VAT, but also diminishes the production distortion between the formal and the informal sectors. The use of a change in the VAT threshold to offset lost tariff revenue leads to welfare gains; however, the source of such gains is different from that of a change in the VAT rate. While an increase in the VAT rate expands informality, a revenue-equivalent decrease in the VAT threshold reduces informality. These novel results suggest that the VAT threshold plays an important role in the design of revenue-neutral tax reforms.
This article analyzes profit taxation according to the arm's length principle in a new model where heterogeneous firms sort into foreign outsourcing. We show that multinational firms are able to shift profits abroad even if they fully comply with the tax code. This is because, in equilibrium, intra-firm transactions occur in firms that are better than the market at input production. Transfer prices set at market values following the arm's length principle thus systematically exceed multinationals' marginal costs. This allows for a reduction of tax payments with each unit sold. The optimal organization of firms hence provides a new rationale for the empirically observed lower tax burden of multinational corporations.
We study the optimal combination of corporate tax rate and tax base in a model of a small open economy with heterogeneous firms. We show that it is optimal for the small country’s government to effectively subsidize capital inputs by granting a tax allowance in excess of the true costs of capital. Economic integration reduces the optimal capital subsidy and drives low-productivity firms from the small country’s home market, replacing them with high-productivity exporters from abroad. This endogenous policy response creates a selection effect that increases the average productivity of home firms when trade barriers fall, in addition to the well-known direct effects.
Despite the microeconomic evidence supporting the superior idiosyncratic productivity of multinational firms (MNFs) and their affiliates, cross-country studies fail to find robust evidence of a positive relationship between foreign direct investment and growth. In order to study the aggregate implications of MNFs entry and production, I develop a dynamic stochastic general equilibrium model with firm heterogeneity where MNFs sort according to their own productivity. Entry and production of MNFs contribute to aggregate productivity growth at decreasing rates and affect domestic producers due to increased product and factor market competition. I argue that the heterogeneous composition of the population of affiliates can help explain the conflicting evidence on the impact of foreign direct investment on growth.
This paper explores the role of country asymmetries for trade and industrial policies with heterogeneous firms. Our analysis delivers a number of novel results. First, trade policies, infrastructure policies and industrial policies which improve the business conditions in one country have negative productivity and welfare effects on the trading partner. Second, symmetric trade liberalization is immiserizing for a trading partner whose business conditions are inferior. Third, there are gains from trade even for a country whose monopolistically competitive sector with heterogeneous firms is wiped out by the switch from autarky to trade.
