The Effect of Third-Country Tariffs on Bilateral Trade

We develop a three-country theoretical framework and provide new evidence on the role of third-country tariffs in shaping bilateral trade flows. Our model predicts that tariff preferences can generate trade diversion and that the magnitude of this effect depends on the full tariff schedule faced by competing suppliers. Leveraging highly disaggregated transaction-level data on South Korea’s imports, we show that bilateral applied tariffs significantly depress imports, while higher third-country tariffs divert trade toward the partner country. These effects are only identifiable when exploiting the richness of our data at the product level and vary substantially across preferential and non-preferential regimes and by the number of potential suppliers. Our findings highlight the importance of accounting for third-country tariffs when assessing the trade effects of tariff changes, a point that is particularly salient in the current context of U.S. policy proposals of tariff increases.