A Second-best Argument for Low Optimal Tariffs
We derive a new formula for the optimal uniform tariff in a small-country, heterogeneous-firm model with roundabout production and a nontraded good. Tariffs are applied on imported intermediate inputs. First-best policy requires that markups on domestic intermediate inputs are offset by subsidies. In a second-best setting where such subsidies are not used, the double- marginalization of domestic markups creates a strong incentive to lower the optimal tariff on imported inputs. In a 186-country quantitative model, the median optimal tariff is 10%, and negative for five countries, as compared to 27% in manufacturing from the one-sector, optimal tariff formula without roundabout production.
We thank Pol Antràs, Kyle Bagwell, John Fernald, Andrés Rodríguez-Clare, and participants at an NBER seminar for helpful comments, along with Anna Ignatenko and Ninghui Li for providing excellent research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.