The Losses from Trade Restrictions: Policy Dynamics with Firm Selection and Endogenous Markup

In this paper, I explore the aggregate effects of trade restrictions in a two-country, dynamic, general equilibrium (DGE) model with firm selection and variable adjustment of markup. As a response to the trade collapse in the global crisis of 2008 and 2009, temporary trade restrictions have emerged in several countries. With analyzing the dynamics of a negative macroeconomic shock in the home economy first, and the subsequent introduction of trade restrictions in the foreign economy second, I show that both economies are in a worse position than they were during the economic downturn. The follow-ups to the recession and trade restrictions are investigated through three mechanisms: (1) variable markup as a new avenue of increasing competitive pressure for producers (e.g. more competitive firms lower their markups); (2) average individual firms' specific productivity cut-off, which induces their optimum export choice (e.g. an increase in the export productivity cut-off means exporting becomes more difficult than before.); and (3) the movement of international relative prices (e.g. the real exchange rate and terms of trade).