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Tariff Pass-Through, Firm Heterogeneity and Product Quality

October 2010

Written by: Zhi George Yu

Working Paper Number:

CES-10-37

Abstract

Previous studies on tariff pass-through were constrained at the industry level. This paper is the first attempt to explore tariff pass-through at the firm level, and to investigate how it depends on firm heterogeneity in productivity and product differentiation in quality. Using an extended version of the Melitz and Ottaviano (2008) model, I show that exporting firms absorb tariff changes by adjusting both their markups and product quality, which leads to an incomplete tariff pass-through. Moreover, tariff absorption elasticity negatively depends on firm productivity for quality differentiated goods, but positively depends on firm productivity for quality homogeneous goods. Using the U.S. transaction level export data and plant-level manufacturing data, I find evidence for these predictions. The firm-level tariff absorption elasticity is 0.87 on average. All products in the sample on average fit the definition of quality differentiated goods, and the tariff absorption elasticity is indeed higher for low productivity firms (1.27) and lower for high productivity firms (0.44). Dividing all products into quality homogeneous goods and quality differentiated goods in terms of various criteria also results in estimates consistent with model predictions for quality differentiated goods.

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:
production, endogeneity, manufacturing, import, export, product, commodity, subsidiary, produce, good, tariff, exporting, gdp, exported, custom, exporting firms

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:
Standard Industrial Classification, National Science Foundation, Center for Economic Studies, Total Factor Productivity, National Bureau of Economic Research, Longitudinal Business Database, World Bank, Census of Manufacturing Firms, Journal of Economic Literature, European Union, Longitudinal Firm Trade Transactions Database

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