Welfare Gains to Trade Reform under Firm Heterogeneity
We develop a model of establishment dynamics consistent with the establishment level heterogeneity in exporting and productivity to analyze the welfare consequences of trade reform. Specifically, we assume that firms face an up-front, sunk cost of entering foreign markets and a smaller period-by-period continuation cost. In response to persistent firm-specific productivity shocks, firms start and stop exporting. The model generates exporter hysteresis in that the productivity threshold to start exporting exceeds the threshold to stop exporting. We calibrate the model to match the characteristics and dynamics of U.S. exporters, and quantify the welfare gains to a world-wide elimination of tariffs. We find that the welfare gains to trade reform depend importantly on transition dynamics. The welfare measure that includes transition dynamics exceed the steady state welfare measure by 5.7 percent of lifetime consumption when a 5 percent tariff rate is eliminated. We also find that the trade to GDP ratio increases by 12.6 percentage points following the trade reform through gradually increased export participation of establishments.
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