This paper explores the welfare costs of trade impediments, which depend on trade elasticities. State-of-the-art literature uses tariffs as instruments to structurally identify them. Studies using Trump tariffs in the US estimate modest elasticities, implying low welfare costs. In this paper, I build a model of political economy to explain these results and introduce a novel identification strategy for estimating them. The model features a selection mechanism for goods chosen for treatment, based on the government’s objective function and the state of the economy. When raising revenue, the government imposes tariffs on sectors with low demand elasticity and strong lobbying power. In response, the other country retaliates by targeting goods with high demand elasticity to maximize economic harm on the trade partner. This model provides a framework for two possible instruments: protectionist and retaliatory tariffs. As trade policy targets the extremes of the elasticity distribution, Trump’s protectionism aligns with the observed low elasticity estimates. In this paper, I find the demand elasticity for imports ranges between 2.5 and 5.2, while the supply elasticity of exports is zero. This suggests that welfare costs could double, reaching up to $22 billion.

This paper estimates the dynamic effects of import tariffs on key macroeconomic aggregates in a small open economy. Due to the countercyclical profile of tariffs, simultaneity between tariffs and GDP induces attenuation bias in the calculation of impulse response functions. To address this issue, we develop a novel instrument based on retaliatory tariffs, constructed from a database of temporary trade barriers. Retaliatory tariff rates are constrained by the World Trade Organization (WTO) to match those imposed by trade partners. The identifying assumption is that tariffs imposed by trade partners are orthogonal to the own economic activity shocks. Retaliation responds to a foreign partner’s defection rather than to domestic economic conditions, allowing the identification of an exogenous import tariff shock using an Proxy-SVAR model. Our key findings are that an increase in tariffs: (i) is inflationary (for consumer prices); (ii) has a negative and quite persistent impact on GDP; and (iii) worsens the trade balance on impact. The results are robust across various alternative specifications and the estimated effects exceed those obtained using standard timing restriction models.

In this paper, we evaluate the role of carbon taxes as automatic stabilizers in small open economies (SOEs) that specialize in the export of a single commodity, particularly those highly dependent on energy inputs for production. Specifically, we examine the carbon tax’s ability to reduce the volatility of the real exchange rate and energy prices. This analysis is conducted through the lens of a DSGE model that incorporates an externality affecting GDP, originating from the burning of fossil fuels for energy generation. We assume this externality drives climate change, and the government, aiming to internalize these damages, imposes a Pigouvian tax on the energy sector. Our model is calibrated for the Chilean economy, which is highly specialized in copper production. The results show that the tax: (i) reduces energy volatility by 14% and energy price volatility by 10%, and (ii) lowers the variance of the real exchange rate by 1.8%. These stabilizing effects are robust to different shock specifications and the choice of model used to represent household consumption.

We analyze a dynamic stochastic general equilibrium model which includes a negative externality that arises from fossil fuels burning. The carbon released to the atmosphere by electricity producers is the main driver of climate change. We adapt the optimal tax derived by Golosov et al. (2011) to a small open economy to force polluters to internalize their damages. The results show that the tax benefits outweigh their costs; yet welfare gains seem to be marginal under plausible parameters. We calculate the optimal carbon tax for Chile and the tax effectiveness achieved, which is around 10 percent. The results remain robust to variations in the utility function, changes in parameters that determine the externality and alternative degrees of commitment to reduce emissions.