Are Capital Goods Tariffs Different?

IMF Working Papers, May 22, 2020

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Firms exposed to a reduction in intermediate and consumption input or output tariffs do not significantly increase their investment rates.
Firms’ investment rate increases strongly in response to a reduction in capital goods input tariffs.
Firms do not substitute capital with labor; they also increase employment, especially for production workers, in response to lower capital goods input tariffs.
Reduction in other tariff rates do not increase investment and employment.
A reduction in the relative price of capital goods can significantly boost investment and employment and does not seem to lead to a decline in the labor share.

Empirical strategy uses exposure to a quasi-natural experiment induced by a trade reform in Colombia.
Focus differentiates capital goods tariffs from other tariffs (intermediate and consumption input or output tariffs).

Lower capital goods input tariffs raise firms’ investment rates.
Employment rises alongside investment, with a notable increase among production workers.
No evidence of capital-for-labor substitution; labor share does not appear to decline following reductions in capital goods tariffs.

Trade reforms that lower capital goods input tariffs can be an effective lever to stimulate firm investment.
Such tariff reductions can also support employment growth without reducing the labor share.
Policymakers should distinguish capital goods tariffs from other tariffs when designing trade liberalization to maximize investment and employment gains.