Do big countries always win a tariff war? A reappraisal

Abstract

In their seminal paper, Kennan and Riezman (1988) show that a "sufficiently" big country is better off under a tariff war compared to free trade. This prediction derived in a setting where market power stems from differences in factor endowments, is somehow puzzling, as the majority of free trade agreements notified to the GATT/WTO are initiated by large rather than small economies. To resolve this puzzle, I use a modified version of the Kennan and Riezman (1988) model to show that the outcomes of a tariff war depend not only on countries' endowment sizes, but also on consumption requirements. In particular, free trade benefits two asymmetric countries if the subsistence level of consumption in the large country is sufficiently higher than in the small country. In addition, free trade between symmetric countries may harm the country with a lower subsistence level of consumption. The theoretical framework presented in this paper supports the idea that even small countries enjoy some market power and thus helps understand why large economies seek free trade in natural resources with smaller commercial partners. P A C S F15, F35

Mobile capital, optimal tariff, and tariff war

“…Naito (2019) establishes a dynamic model to explain the fact that the low‐income countries had the highest mean tariff, followed by the middle‐ and high‐income countries 6 . Meanwhile, Kilolo (2018) generalizes the model of Kennan and Riezman (1988) and shows that the outcomes of a tariff war depend not only on country sizes but also on consumption requirements. If larger countries have higher consumption requirements, smaller countries may set higher tariff rates and may win tariff wars.…”