Optimal Tariff Policy Making Under Parallel Importation

ABSTRACT Governments are increasingly paying attention to optimizing tariff policies to address the challenges posed by parallel importation, which has become a ubiquitous business phenomenon. This article establishes an endogenous tariff model that investigates how government tariff policies affect multinational firms' (MNF's) pricing strategies and the resulting impact on parallel importation. Our study demonstrates that when the perceived value of parallel imports and the demand difference are high, the government will set the optimal tariff that induces the MNF to adopt the pricing strategy of encouraging the gray market to achieve higher tariff revenue and social welfare. Otherwise, the government will impose a high tariff to raise the parallel importation cost, thereby inducing the MNF to adopt the pricing strategies of preventing or eliminating parallel importation. Moreover, the government sets a lower tariff due to parallel importation, and the MNF can strategically adjust its pricing strategy to address parallel importation concerns. Thus, the equilibrium outcomes resulting from the government's tariff policy may either align or conflict with the MNF's interests, and the impact of parallel importation on social welfare and the MNF's profit varies. Specifically, when both the demand difference and the perceived value of parallel imports are moderate, parallel imports benefit both the government and the MNF, achieving a Pareto improvement outcome. When both the demand difference and the perceived value of parallel imports are high, parallel importation may enhance social welfare but harm the MNF. When the demand difference is large but the perceived value of parallel imports is low, parallel importation may benefit the MNF but harm social welfare.