Trade Liberalizations with Granular Firms

We quantify the effects of trade liberalization accounting for a fact identified with rich firm-product Danish data: the bulk of manufacturing revenue comes from industries where domestic leaders coexist with a competitive fringe. Our framework features firm-level heterogeneity, extensive-margin adjustments, and allows for a subset of non-negligible firms that behave strategically and have positive profits which are passed back to consumers. In this setup, since profits are affected positively by new export opportunities but negatively by tougher competition, gains of trade are not guaranteed. Estimating the model establishes that a trade liberalization increases Danish income and, hence, welfare. Nonetheless, the predicted gains are substantially lower than if we characterize firms as in the standard monopolistic competition framework.