Trade, firm selection, and industrial agglomeration

We develop a model of trade and agglomeration that incorporates trade in both intermediate goods and final goods and allows all firms to choose their locations. There are two types of labor: skilled labor, which is mobile, and unskilled labor, which is immobile. Upon choosing its factory site, a final goods firm that is managed by skilled labor can produce these goods using local unskilled labor and a variety of intermediate goods produced by productivity-heterogeneous producers. We characterize world equilibrium and establish the conditions under which industrial agglomeration arises as a stable equilibrium outcome. We show that when the unskilled labor force is small, the role played by the selection of intermediate firms becomes less important, and trade liberalization induces dispersion. When the unskilled labor force is large and the selection effect becomes influential, trade liberalization can generate non-monotonic effects on industrial agglomeration. The dispersion effect of trade liberalization arises when unskilled labor–intermediate input complementarity matters to firm selection to a greater degree. When this is the case, trade liberalization may induce less selective firm entry and cause average productivity to fall.