Tariff discrimination for co-existence of domestic and foreign firms with increasing marginal costs

Abstract

When foreign exporters and domestic firms are allowed to produce under asymmetrically increasing marginal costs, the high-cost exporter is handicapped, whereas the low-cost exporter is subsidized in a discriminatory tariff regime. Thus, the profit of the high-cost (low-cost) exporter is smaller (larger) under discriminatory tariffs than under uniform ones. Regardless of the domestic firm type, total output, consumer surplus, low-cost exporter profits, and social and global welfare are always greater under discriminatory tariffs than under uniform ones. Even when exporters and low- and high-cost domestic firms coexist, our main results hold, while both types of domestic firm prefer uniform tariffs to discriminatory ones.

Keywords:

• Increasing marginal cost
• uniform and discriminatory tariffs
• domestic firms

JEL Classifications:

• F12
• F13
• L13

Acknowledgements

The authors are grateful to the Editor, Prof. Lex Zhao and anonymous referees for their valuable comments on our paper.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 See Bagwell and Staiger (1999), Horn and Mavroidis (2001), McCalman (2002), Saggi (2004) and Bagwell and Staiger (2010) for analyzes of the various legal and economic aspects of MFN. See also Tabakis (2015) for FTA.

2 An analysis of PTAs involving 85 countries and 90 percent of world trade in 2007 found that roughly two-thirds of tariff lines with MFN rates greater than 15 percent were not reduced through PTAs (Bagwell, Bown, and Staiger 2016).

3 The quadratic cost is popular in IO. For example, see von Weizsäcker (1980), Dastidar (2001), Gori, Lambertini, and Tampieri (2014), Delbono and Lambertini (2016a, 2016b), and Chen (2022). Most natural cases of diminishing marginal return technologies are cases where some industries are unable to replicate some inputs, i.e. due to the presence of some fixed inputs (Varian 1992, 16). Basu and Fernald (1997) found that a typical industry appears to have significantly decreasing returns to scale, using aggregate data to estimate the production of 34 manufacturing industries in the U.S.; see the references therein.

4 Din, Andy Wang, and Liang (2016) showed that the importing government tends to impose a lower (higher) tariff on low-cost (high-cost) firms and global welfare is higher under a discriminatory tariff than under a uniform one if the magnitude cross ownership of financial interests is relatively high. We discuss the differences between Din, Andy Wang, and Liang (2016) and our study in Section 3.

5 Saggi (2004) considered a model of n countries and n exporters with differential costs. He found that each country imposes higher tariffs of efficient exporters, while the adoption of the MFN clause by each country improves global welfare. Saggi and Yildiz (2005) considered that each exporting country has two exporters and showed that tariff discrimination can be welfare preferred to MFN globally when inefficient exporters are merged and the cost disadvantage of the merged unit relative to competing exporters is of intermediate magnitude.

6 Although we employed only one home firm (low-cost or high-cost) separately in the importing country, the main results of the extension will still held.

7 If we use $n(i=1,2,\dots ,n)$ firms, the utility function of the representative consumer is given as $U=\sum _i^n{q}_i-\sum _i^n(1/2)q_i^2-\sum _{i\ne j}^{n}d{q}_i{q}_j-\sum _i^n{p}_i{q}_i.$

8 Some readers may concern that it should consider the case of Bertrand competition. If we employ Bertrand competition with same setting, we find the same results can obtain. The detailed computations are available from authors upon request. For the computations, see K. Choi and Lim (2019).

9 The assumption is also widely applied in the literature on international trade even though the importing country has a monopsony power.

10 Although Din, Andy Wang, and Liang (2016) also showed that the importing government tends to impose a lower (higher) tariff on low-cost (high-cost) firms, this result crucially depends on the magnitude of cross ownership being relatively large compared with the cost difference, assuming constant marginal costs. Lemma 3.1 in this study always holds true without such constraints.

11 If we extend the framework to Bertrand competition, the assumption d = 1 forces the analysis to fail since firms cannot produce a positive output from the direct demand function, $q_i=\frac{1-d-(1+2d)p_i+d(p_h+p_j+p_k)}{(1-d)(1+3d)}$. Hence, if we simplify the analysis with the homogeneous product assumption under either Cournot or Bertand competition, the essential argument is affected by the simplification of the model based on the increasing marginal costs.

12 That would mean that the increasing marginal costs seem to eliminate tariff discrimination when products are homogeneous, even when the importing country can discriminate.

13 Without a loss of generality, we can further assume that ${\alpha }_i>{\alpha }_j$ and ${\alpha }_k>{\alpha }_h$. In other words, the vertical intercept of firm i's and firm k's net marginal cost curves is larger than firms j's and h's, whereas the slope (increasing rate) of the formers ($m_i$ and $m_k$) is allowed to be either greater than, less than, or equal to that of the latter two ($m_j$ and $m_h$).

14 In the absence of home firms, an extension of our model was created by K. Choi (2022). It deals with exporters' endogenous choice of competition mode. The differences between K. Choi's (2022) and our work are that (i) with increasing marginal costs for any degree of product differentiation, there is the possibility that the preferences for tariff regimes change in the same direction for the exporters' profits, consumer surplus, and social and global welfare; and (ii) it does not analyze the presence of home firms. This is because discriminatory tariffs lead to Cournot competition, whereas uniform tariffs lead to diverse modes of competition.Furthermore, it is interesting to extend the issue of the scope of bargaining between duopolistic firms and unions with strategic trade policy. See Fanti and Buccella (2016) for endogenous bargaining framework.

15 We use ‘The Mathematica 8.2’ (see Wolfram 1999) for the figures of this paper.

16 We use ‘The Mathematica 8.2’ (see Wolfram 1999) for the figures of this paper.

17 We use ‘The Mathematica 8.2’ (see Wolfram 1999) for the figures of this paper.