Tariff Reductions, Heterogeneous Firms, and Welfare: Theory and Evidence for 1990–2010

We construct a new, global tariff dataset and apply it to a multi-sector quantitative trade model with heterogeneous firms, including nearly all countries of the world. The impact of the Uruguay Round tariff reductions over 1990–2010 is analyzed, as well as the further cuts in Preferential tariffs and the impact of moving to complete free trade. We find that the Uruguay Round tariff cuts led to large welfare gains (2%–3% relative to 1990 for the world, higher in Emerging and Developing countries), but that Preferential tariff cuts led to only small further gains (0%–1%). Surprisingly, the hypothetical movement to free trade leads to the greatest gains (5% relative to 1990, almost 10% in Emerging and Developing countries), which implies that there is strong scope for gains from future multilateral tariff reductions, especially for Emerging and Developing economies. These gains are large relative to prior estimates in the literature and we attribute about nearly one-half of our measured gains to selection effects in our heterogeneous-firm model, which are influenced by the scale of production and by two-tier Armington aggregation.