A welfare ranking of multilateral reductions in real and tariff trade barriers when firms are heterogenous
Trade liberalization comes about through reductions in various types of trade costs. This paper introduces, apart from real variable (i.e. iceberg) and fixed export costs, two partially redistributed tariffs into a Melitz (2003) model. We present comparable results for welfare effects and changes in industry structure by analyzing the different liberalization channels for an equal effect on openness. The welfare ranking is sensitive to the degree of efficiency in tariff redistribution, e.g. the share of tariff revenues wasted on rent-seeking activities. Ad valorem tariff cuts switch from the least to the most preferred mode of liberalization as the fraction of tariffs wasted moves from zero to unity. Apart from a situation with no tariff redistribution, reductions in iceberg trade costs are preferred to reductions in real fixed trade costs which again are preferred to cuts in unit tariffs.
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