Tariff Burden Shifts: Who Really Pays for Trade Shocks?

New Research Explores Firm-to-Firm Dynamics

Understanding how the cost of international trade disputes, like tariffs, affects businesses is crucial. New research delves into the complex web of firm-to-firm relationships to reveal who absorbs these economic blows.

Unpacking Trade Cost Incidence

When costs rise for foreign suppliers, the key question is how much of that increase is passed on to domestic buyers. This phenomenon, known as cost shock incidence, is central to international trade policy. Economists are examining these dynamics through novel modeling approaches.

Modeling Trade Networks

A recent study by **Fontaine et al.** introduces a firm-to-firm trade model incorporating search frictions. This framework acknowledges that international trade relies on a network of specific business relationships. Unlike simpler models, it allows for a nuanced examination of how price negotiations and market power influence cost pass-through.

The model posits that buyers typically only interact with a limited set of suppliers. This restricted competition impacts the prices they secure. However, as buyers continuously search for new partners, their bargaining power can increase, forcing existing suppliers to lower their prices or markups.

Price Heterogeneity and Evolution

This approach helps explain observed patterns in international trade. It suggests significant variation in prices and markups exists between different buyer-supplier pairings. These differences arise because each buyer’s available alternatives, shaped by their search process experience, vary. Markups can differ even for the same supplier selling to different customers.

Furthermore, prices within ongoing trade relationships tend to decrease over time. As buyers expand their search and discover more potential suppliers, their bargaining position strengthens, pressuring incumbent suppliers to offer better terms. This aligns with recent empirical findings.

Simulating Cost Shock Impacts

Using this sophisticated model, researchers simulated the impact of a hypothetical cost increase affecting all suppliers from a specific country. The findings reveal a highly uneven distribution of the burden among buyers.

In some instances, buyers remained unaffected as their suppliers absorbed the entire cost increase due to competitive pressures from other available options. In other cases, buyers were forced to switch to less competitive suppliers, leading to higher prices. The model also shows how a supplier’s competitor being affected by the same shock can enable that supplier to raise its prices.

Empirical Evidence from France

To ground their theory, the researchers analyzed detailed data on exports from French firms to their European Union buyers. They estimated search frictions across various sectors and markets.

A simulation of a 10% cost shock to French suppliers revealed that, one month later, EU buyers experienced an average 3.6% increase in import prices. This indicates that buyers bore 36% of the cost increase. However, this average masks considerable variation.

In a typical market segment, a quarter of buyers faced a full 100% price increase, while 40% saw no change. Over 25% of buyers switched suppliers, facing an average price jump of 30%. Markets with higher matching rates, implying lower search friction, showed buyers bearing a larger price increase – on average, twice as much compared to markets with higher friction.

Policy Implications for Support

The study suggests that government support for firms impacted by foreign supplier shocks needs careful targeting. Simply assisting firms that rely on affected suppliers might be inefficient, as some buyers will absorb no additional costs.

Policy could focus on market segments with high search frictions, where buyers are likely to face greater price increases. Alternatively, providing assistance to buyers to diversify their supplier base after a shock could be effective. Buyers experiencing higher cost burdens would be more inclined to utilize such programs, while those unaffected would likely opt out.

For context, in 2023, the United States imported approximately $3.0 trillion in goods, with a significant portion subject to tariffs and trade policies that could trigger such cost pass-through effects (U.S. Census Bureau).