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US Tariffs in a Model with Trade and FDI

Author

Listed:
  • Kaan Celebi
  • Werner Roeger

Abstract

The new US administration has a clear agenda of reducing imports to the US and attract FDI by reducing tariffs and using the proceeds for supporting investment in the US. This paper uses a dynamic two country US vs RoW model where monopolistically competitive firms make export and FDI decisions. We study how this additional FDI channel affects the impact of import tariffs on the US and RoW economy. We model both the international supply linkages of domestic producers and subsidiaries of foreign firms as well as EoS of FDI sales with domestic products and imports in order to capture cost and demand channels affecting FDI decisions. Concerning the respective elasticities we use both trade elasticities as well as estimates on the effect of tariffs on the import to inward FDI sales ratio. We are in particular interested how the use of tariff revenues affects the outcome of a tariff. We find that a unilateral US tariff with transfers to households has positive effects on US consumption and leads to rising inward FDI and reduces US imports. However, rising production and investment cost reduce total US investment. A real dollar appreciation cushions the effect of tariffs on RoW exporters but increase the cost for production and investment, generating a negative spillover to the RoW. If tariffs are accompanied by investment subsidies the expansionary effects for the US are significantly larger and total US investment becomes positive. This holds especially for FDI flows to the US. The investment boom generated in the US increases world interest rates. This contributes to larger negative spillovers to the RoW. The use of tariff revenues also affects how the US and RoW are affected in case of (full) retaliation. In case of transfers, the US is hit more since higher openness increases cost of production and investment more in the US. This ranking is reversed in case of subsidies. Higher US openness generates more tariff revenues as a share of GDP and therefore more investment subsidies.

Suggested Citation

  • Kaan Celebi & Werner Roeger, 2025. "US Tariffs in a Model with Trade and FDI," Discussion Papers of DIW Berlin 2111, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp2111
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    References listed on IDEAS

    as
    1. Julian Thimme, 2017. "Intertemporal Substitution In Consumption: A Literature Review," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 226-257, February.
    2. Warwick J. McKibbin & Megan Hogan & Marcus Noland, 2024. "The international economic implications of a second Trump presidency," Working Paper Series WP24-20, Peterson Institute for International Economics.
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    More about this item

    Keywords

    international trade; foreign direct investment; import tariffs; USA; two-country open economy model;
    All these keywords.

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy

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