Optimal tariffs, tariff jumping, and heterogeneous firms

The majority of research to date investigating strategic tariffs in the presence of
multinationals finds a knife-edge result where, in equilibrium, all foreign firms are either
multinationals or exporters. Utilizing a model of heterogeneous firms, we find equilibria
in which both pure exporters and multinationals coexist. We utilize this model to study
the case of endogenously chosen tariffs. As is standard, Nash equilibrium tariffs are
higher than the socially optimal tariffs. Unlike existing models with homogeneous
firms, we find that non-cooperative tariffs promote the existence of low-productivity
firms relative to the socially optimal tariffs. This highlights a new source of inefficiency
from tariff competition not found in models of homogeneous firms. In addition, we find
that in many cases the Nash equilibrium tariff when FDI is a potential firm structure
is lower than when it is not. As a result, FDI improves welfare by mitigating tariff
competition.