Social Insurance in an open Economy: Tariffs vs. Redistributive Taxation

The United States has shifted sharply toward a protectionist trade policy, imposing historically high tariffs on its trading partners. A central rationale for this shift is to reverse deindustrialization and rebuild domestic manufacturing. In the U.S., low-skilled workers remain disproportionately concentrated in import-competing manufacturing sectors and are therefore more exposed to import competition. While tariffs may provide insurance by shielding workers in import-competing sectors, they also distort production and raise the price of consumption goods. These opposing forces create a fundamental policy trade-off that requires analyzing tariffs jointly with the rest of fiscal policy. In this paper, we quantify the efficiency–distribution trade-off generated by protectionist trade policy in a two-country heterogeneous-agent Ricardian model with incomplete markets, capital accumulation, and non-homothetic preferences. The model features sectoral reallocation between tradable and nontradable sectors, capital–skill complementarity, and uninsurable idiosyncratic income risk. Trade shocks propagate through relative wages, investment, and household self-insurance decisions within a progressive tax and means-tested transfer system. Calibrated to the U.S. economy, a unilateral permanent 15 percent tariff reduces long-run GDP by 4.4 percent and capital by 10.6 percent, raises tradable prices, and compresses the skill premium by 7 percent, thereby lowering wage inequality and modestly easing redistributive pressure at the
cost of substantial efficiency losses and lower aggregate consumption. Under full retaliation, aggregate losses are smaller, but price distortions are amplified, and distributional
effects are muted. Overall, tariffs partially insure exposed workers and compress wage differentials, yet do so by exacerbating allocative distortions and depressing long-run
output and capital accumulation.