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How Tariffs Affect Trade Deficits
We study the positive (not normative) effect of a permanent import tariff on trade deficits. We consider a two-period trade model with general preferences and technology. We first develop an aggregation result showing one can work with induced preferences over aggregate imports and exports. This simplifies the analysis considerably. Our main result provides a sufficient statistic to evaluate the impact of tariffs around free trade: tariffs reduce trade deficits if the Engel curves for aggregate imports and exports are convex. Convexity is more likely when goods, at the micro-level, shift between being imported, non-traded, or exported. If this extensive margin is inactive and Engel curves are linear, then a permanent tariff is neutral.
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