Do Big Countries Win Tariff Wars?

It is well known that large countries can manipulate the terms of trade to their advantage by using tariffs. It is widely believed, however, that this invites retaliation, and that the post-retaliation equilibrium leaves all countries worse off than they would be at free trade. We present a simple pure exchange model and show which endowment patterns are consistent with this belief. In this model, we find that if one country is substantially bigger it can expect to gain from a tariff war, despite retaliation. Thus we suggest that big countries win tariff wars. We believe that this provides a potentially important explanation for the persistence of tariffs, and the difficulty of attaining free trade. Our model can also be extended to show that when more than two countries trade with each other, the advantage obtained by being part of a large trading unit can help explain the formation of customs unions (see Kennan and Riezman 1987)…