Firm Input Choice Under Trade Policy Uncertainty

67 Pages Posted: 14 Oct 2020

See all articles by Kyle Handley

Kyle Handley

University of Michigan, Stephen M. Ross School of Business

Nuno Limão

University of Maryland - Department of Economics

Rodney D. Ludema

Georgetown University - Department of Economics

Zhi Yu

Sun Yat-Sen University (SYSU) - School of Intelligent Systems Engineering

Date Written: October 2020

Abstract

We examine the role of trade policy uncertainty in shaping the import decisions of firms. If the adoption of a new input requires a sunk cost investment, then the prospect of price increases in that input, e.g. due to trade barriers, reduces the adoption of that input (a substitution effect) and possibly other inputs (complementarity via lower profits). Thus trade policy uncertainty can affect a firm’s entire input mix. We provide a new model of input price uncertainty that captures both effects and derive its empirical implications. We test these using an important episode that lowered input price uncertainty: China’s accession to the WTO and the associated commitment to bind its import tariffs. We estimate large increases in imported inputs by firms from accession; the reduced uncertainty from commitment generates substitution effects larger than the reductions in applied tariffs in 2000-2006 and has significant profit effects.

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Suggested Citation

Handley, Kyle and Limão, Nuno and Ludema, Rodney D. and Yu, Zhi, Firm Input Choice Under Trade Policy Uncertainty (October 2020). NBER Working Paper No. w27910, Available at SSRN: https://ssrn.com/abstract=3709599

Kyle Handley (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Nuno Limão

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States
301-405-7842 (Phone)
301-405 3542 (Fax)

Rodney D. Ludema

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-1429 (Phone)
202-687-6102 (Fax)

Zhi Yu

Sun Yat-Sen University (SYSU) - School of Intelligent Systems Engineering ( email )

Guangzhou, 510275
China

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