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No 99

Optimal Tariffs with Firm Heterogeneity, Variable Markups, and FDI

  • Abstract

    Variable markups and multinational production have gathered considerable attention in the trade literature because of their empirical prevalence and welfare implications. This paper studies the welfare implication of tariffs and optimal tariffs in an environment that features firm heterogeneity, variable markups, and FDI. I find: (i) Tariffs endogenously affect firm entry level, producing different comparative statics in the short run versus long-run. (ii) Variable markups generate multiple externalities in this economy, causing market outcome to differ from the socially optimum outcome systematically. Permitting tariff-jumping FDI can lower the domestic cutoff levels and reduce the misallocation in the economy. (iii) Free trade is not always socially optimal. If the domestic marginal cost cutoff is sufficiently high, a positive tariff can be welfare-improving since it encourages firm entry. The Nash equilibrium tariff level will also be higher than the socially optimal tariff. (iv) The interaction of variable markup and FDI generates novel welfare implications that are absent if consumers possess CES preference.

    Keywords: Optimal tariff, Firm heterogeneity, Misallocation, Variable markups, FDI.

    JEL codes: F12, F13, F23, F60, R13.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

No 92

Firm Heterogeneity, Variable Markups, and Multinational Production: A Review from Trade Policy Perspective

  • Abstract

    This paper surveys the main ingredients and results of heterogeneous firms trade policy literature that has been developing since the early 2000s. First, I present the stylized facts regarding firm heterogeneity, firmlevel markups, and multinational production’s global structure. I then survey the trade policy papers that build on the workhorse model of firm heterogeneity. Third, I summarize the recent development of theoretical approaches of modeling the firm-level markups and its trade policy implication. Fourth, I discuss the theoretical frameworks that incorporate multinational production into heterogeneous firms’ framework and their trade policy implication. Finally, I discuss directions for future research and offer suggestions for further readings.

    Keywords: Trade policy, Firm heterogeneity, Variable markups, Multinational production.

    JEL codes: F12, F13, F23, F60.

    The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.