Comparative Advantage and Economies of Scale under Uncertainty

We study how regional specialization patterns and welfare are affected by uncertainty and economies of scale in an open economy. We use a spatial equilibrium model with sectoral economies of scale, aggregate uncertainty, and irreversible mobility decisions made by heterogenous workers. We analytically characterize how the interactions between comparative advantage, both of workers and firms, economies of scale, and uncertainty shape specialization patterns and, hence, the gains from trade. We find empirical support for the model predictions by documenting the impact of aggregate changes in volatility of sectoral productivity on U.S. regional economies. We calibrate the model using detailed data on U.S. commuting zones and international trade, and extending hat-algebra methods to accommodate uncertainty. Quantitatively, we find that uncertainty shifts employment away from riskier sectors and locations, relative to a deterministic benchmark, lowering the U.S. aggregate gains from trade by around 20 percent. The interaction between uncertainty and scale economies brings down the benefits of specialization. For regions that would otherwise lose from trade, the presence of agglomeration forces and a more elastic labor supply mitigates those losses.