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Trade liberalization, heterogeneous firms and the soft budget constraint

  • Alexeev, Michael
  • Jang, Yong Joon

We analyze the interaction between the soft budget constraint (SBC) and international trade by placing Segal's (1998) SBC model within Melitz's (2003) framework of international trade with heterogeneous monopolistically competitive firms. As in Segal's model, SBC may result in moral hazard. The opening to international trade adds another sort of inefficiency. Some firms that would have become exporters in the absence of SBC choose to apply low effort and not export in order to extract a subsidy from the government. This effect takes place when the trade costs are sufficiently low. Overall, however, trade liberalization reduces inefficiencies generated by SBC. The number of firms subject to moral hazard SBC decreases, aggregate effort level increases and aggregate profits lost due to SBC-induced sub-optimal effort decline as trade costs decrease.

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

Volume (Year): 38 (2010)
Issue (Month): 4 (December)
Pages: 449-460

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Handle: RePEc:eee:jcecon:v:38:y:2010:i:4:p:449-460
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622864

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  1. di Giovanni, Julian & Levchenko, Andrei A., 2013. "Firm entry, trade, and welfare in Zipf's world," Journal of International Economics, Elsevier, vol. 89(2), pages 283-296.
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  9. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
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