INSIDE GLOBAL ISSUES
Working Paper No. 201514
The Armington Assumption and the Size of Optimal Tariffs
Li Chunding, Jing Wang, John Whalley
Abstract: There has been commentary on the seeming success of the world trading system responding to the large shock of the 2008 financial crisis without an outbreak of retaliatory market closing. The threat of large retaliatory tariffs and fears of a 1930s style downturn in trade have been associated with numerical trade modelling which project post retaliation optimal tariffs in excesses of 100%. In the relevant numerical modelling it is common to use the Armington assumption of product heterogeneity by country. Here we argue and show by numerical calculation that the widespread use of this assumption gives a large upward bias to optimal tariffs, both first step and post retaliation, relative to alternative homogenous good models used in trade theory.
Keywords: Optimal Tariffs, Armington, Homogeneous Goods, Numerical Modelling
1. Introduction
The reasons why the Armington assumption is so widely used in numerical modelling are well documented (see Whalley (1975) and Srinivasan and Whalley (1986)). First, there is the size of intra-industry trade, which for the US can run at 80% of gross trade for 2 digit HS trade data. Netting out trade flows as would be implied by use of a homogenous goods trade model in the Hecksher-Ohlin tradition seems to unrealistically shrink the role of trade. Second comes the feature of conventional goods and factors models that the implied production possibilities frontiers with conventional (Cobb-Douglas, CES) production functions are close to linear (see Johnson, 1966) resulting in specialization in production in the model for even small changes in trade policies such as tariffs. Third comes the convenience of allowing for model calibration via the elasticities of substitution in preferences among Armington goods to literature estimates of import price elasticities.
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2. Groups of Models and the Experiments
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3. Data and Model Calibration
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4. Optimal Tariff Calculations
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5. Conclusions
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