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Trade policy under firm-level heterogeneity in a small economy

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  • Demidova, Svetlana
  • Rodríguez-Clare, Andrés

Abstract

We explore the effect of trade policy on productivity and welfare in the now standard model of firm-level heterogeneity and product differentiation with monopolistic competition. To obtain sharp results, we restrict attention to an economy that takes as given the price of imports and the demand schedules for its exports (a "small economy"). We first establish that welfare can be decomposed into four terms: productivity, terms of trade, variety and curvature, where the last is a term that captures heterogeneity across varieties. We then show how a consumption subsidy, an export tax, or an import tariff allows our small economy to deal with two distortions that we identify and thereby reach its first-best allocation. We also show that an export subsidy generates an increase in productivity, but given the negative joint effect on the other three terms (terms of trade, variety, and curvature), welfare falls. In contrast, an import tariff improves welfare in spite of the fact that productivity falls.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 78 (2009)
Issue (Month): 1 (June)
Pages: 100-112

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Handle: RePEc:eee:inecon:v:78:y:2009:i:1:p:100-112

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Web page: http://www.elsevier.com/locate/inca/505552

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Keywords: Trade policies Firm heterogeneity;

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  1. Marc J. Melitz & Fabio Ghironi & Florin O. Bilbiie, 2007. "Monopoly Power and Endogenous Variety in Dynamic Stochastic General Equilibrium: Distortions and Remedies," 2007 Meeting Papers 772, Society for Economic Dynamics.
  2. Baldwin, Richard & Forslid, Rikard, 2004. "Trade Liberalization with Heterogenous Firms," CEPR Discussion Papers 4635, C.E.P.R. Discussion Papers.
  3. Andrew B. Bernard & Jonathan Eaton & J. Bradford Jensen & Samuel Kortum, 2003. "Plants and Productivity in International Trade," American Economic Review, American Economic Association, vol. 93(4), pages 1268-1290, September.
  4. Helpman, E., 1990. "Monopolistic Competition In Trade Theory," Princeton Studies in International Economics 16, International Economics Section, Departement of Economics Princeton University,.
  5. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
  6. Melitz, Marc J, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," CEPR Discussion Papers 3381, C.E.P.R. Discussion Papers.
  7. S. Baranzoni & P. Bianchi & L. Lambertini, 2000. "Market Structure," Working Papers 368, Dipartimento Scienze Economiche, Universita' di Bologna.
  8. Flam, Harry & Helpman, Elhanan, 1987. "Industrial policy under monopolistic competition," Journal of International Economics, Elsevier, vol. 22(1-2), pages 79-102, February.
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