Comparison of deep integration in the Melitz, Krugman and Armington models: The case of The Philippines in RCEP

We estimate the welfare effects of a modern mega-preferential trade agreement--the Regional Comprehensive Economic Partnership--with three versions of market structure: (i) perfect competition, Armington style; (ii) monopolistic competition based on Krugman (1980); and (iii) monopolistic competition in the style of Melitz (2003). We develop a new numerical model of foreign direct investment (FDI) with heterogeneous firms and extension of the Krugman model that allows small countries to impact the number of varieties. We hold both the trade and FDI responses constant across the three market structures. We find that in all three market structures, there are substantial gains from deep integration, but virtually no gains from preferential tariff reduction. Both our Krugman and Melitz style models produce significantly larger welfare gains than the Armington structure, especially if third countries benefit at least partially from the deep integration reforms via either spillovers or wider liberalization.