The distributional consequences of trade liberalization: Consumption tariff versus investment tariff reduction

This paper uses numerical simulations to highlight the contrasting effects of consumption and investment tariff reductions on the dynamic adjustments of key measures of aggregate activity and inequality. The consumption tariff has only a weak effect on activity. If implemented instantaneously it leads to a negligible reduction in wealth inequality but a substantial increase in income inequality. If gradual, it causes a more significant decline in wealth inequality but a milder increase in income inequality. A comparable reduction in an investment tariff increases activity significantly. It leads to a significant long-run reduction in wealth inequality if implemented instantaneously, which is moderated if introduced gradually. It is associated with a tradeoff between the short-run and long-run effects on income inequality, reducing it in the very short run, while increasing it slightly over time. The simulations are supplemented with extensive sensitivity analysis, suggesting some sensitivity to key structural parameters.