Intra-industry Trade and Trade Liberalization: Evidence from Preferential Tariffs Data∗

Does exchanging similar products within the same industry facilitate trade liberalization? While decades of theoretical research identified forceful political and economic reasons for open trade in the presence of high intra-industry trade, there exists surprisingly little empirical evidence supporting the claim. We contend that the lack of evidence is attributable to the common practice of country-level analysis based on most favored nation (MFN) tariff rates. Specifically, we argue that aggregation bias arises because MFN rates do not differentiate the preferential treatments given to partners with whom a country engages in high intra-industry trade. We construct a large scale database with more than 300 million observations that links partner specific trade volumes to preferential tariffs rates for each HS6 product. We find strong effects of intra-industry trade on trade liberalization. The effect is especially pronounced for industries with high variation in tariffs. We then focus on the free trade agreement between the U.S. and Korea where more than 60% of products are exported (and imported) by both countries. We find that products with higher levels of two-way trade prior to the agreement enjoyed more reduction of tariffs deviating from the baseline MFN rates. ∗We thank Daniel Kono for generously sharing his data. We also thank Tucker Cheyne and Hyungsuk Yoon for their excellent research assistance. †Assistant Professor, Department of Political Science, Massachusetts Institute of Technology, Cambridge MA 02139. Phone: 617–253–3138, Email: [email protected], URL: http://web.mit.edu/insong/www/ ‡Ph.D. student, Department of Political Science, Massachusetts Institute of Technology, Cambridge MA 02139.