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Welfens, P.J.J.: The Optimum Import Tariff in the Presence of Outward Foreign Direct Investment

Welfens, P.J.J.: The Optimum Import Tariff in the Presence of Outward Foreign Direct Investment


JEL classification: F13, F15, F21, F23

Key words: import tariff, big economy, optimum tariff, outward foreign direct investment, US and China



International Economics shows in the field of import tariff analysis that for small open economies the optimum import tariff is zero, while for a large economy the welfaremaximizing import tariff is given by 1/E’ where E’ is the foreign supply elasticity. This result, however, no longer holds if there is foreign direct investment in the respective export sector abroad. The higher the share of outward cumulated FDI in the foreign export sector is, the higher the dampening effect on the traditional optimum import tariff. As cumulated outward FDI has become rather important in the case of US and EU FDI in China, Japan, India and other countries, it is important to reconsider optimum import tariffs. It is argued that outward FDI could also affect optimum import tariffs through a macroeconomic channel, namely the effect of changes in net income from abroad. Since the optimum tariff will affect the real exchange rate, FDI in turn will be affected by the tariff policy – in line with the FROOT/STEIN argument on the real exchange rate affecting international FDI inflows and FDI outflows, respectively. Moreover, both outward FDI in the tradable and non-tradable sectors are relevant. In the US-China tariff conflict under President Trump, the FDI-related aspects have been ignored – and similarly in the UK with respect to No-Deal tariffs vis-à-vis the EU27 - so that import tariffs imposed/announced in several sectors are too high.


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