Vertical Specialization, Tariff Shirking, and Trade


The core idea behind the paper is that trade policy matters for the organization of global value chains, a notion largely neglected by economists but which has important implications to understand trade and the international transmission of trade policy shocks. The paper develops a theoretical model in which a firm’s ability to spatially separate manufacturing from headquarter services gives them the flexibility to circumvent economy-specific tariff changes by switching their assembly location abroad. It shows that tariff shirking increases the elasticity of bilateral trade to economy-specific tariff hikes due to an extra extensive margin effect. Furthermore, tariff shirking affects the vulnerability of headquarter services and manufacturing to trade policy shocks in opposite ways.

While tariff shirking dampens the vulnerability of headquarter services to trade policy shocks, it amplifies the vulnerability of manufacturing to trade policy shocks. Using firm-level and province-level export data from the People’s Republic of China, this paper provides evidence in line with the theoretical model.