The long-term impact of trade with firm heterogeneity
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The long‑term impact of trade with firm heterogeneity Guzmán Ourens1
© The Author(s) 2020
Abstract This paper explores the welfare effects of openness in a setting with firm heterogeneity and country asymmetry and presents results in terms of the well-known formula from Arkolakis et al. (Am Econ Rev 102(1):94–130, 2012). By allowing agents to save and the economy to grow, new channels for the welfare effects of openness appear, since firm selection affects the value of accumulated savings and the average efficiency of the economy, and therefore its future growth rate. Country asymmetry yields differentiated, and in some cases opposite, results between countries. In line with the empirical literature, net welfare effects in each region depend on countries’ specific conditions and losses may occur. A numerical exercise fits the model to the UK and EU economies to show the magnitude and direction that each effect can take if trade barriers increase between them. It is shown that welfare losses for UK consumers can be greatly underestimated if asymmetries and dynamics are removed from the analysis. Keywords Firm heterogeneity · Expanding varieties · Asymmetric countries · Welfare · Trade liberalization JEL Classification F12 · F15 · O40
1 Introduction The emergence and development of the heterogeneous firm trade model (HFTM) that followed the seminal work of Melitz (2003), has provided great insights on the mechanisms through which trade openness affects economies, highlighting withinindustry resource reallocation. A standard result in the HFTM is the increase in welfare for consumers of all countries involved, following trade liberalization. In Melitz (2003) and Helpman et al. (2004), openness provides incentives for the most efficient * Guzmán Ourens [email protected] 1
Department of Economics, Tilburg University, Warandelaan 2, 5037 AB Tilburg, The Netherlands
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firms in the industry to export and expand while low-productivity firms are forced out by tougher competition, in a process of firm selection. As a result, resources move from the latter firms to the former, average efficiency in the industry increases and welfare rises due to the subsequent reduction of the price index. The HFTM has been extensively used over the last decade to account for many previously unexplained facts in the trade literature. However, most extensions have remained either static in nature, or assume symmetric countries. This paper contributes to the trade and growth literature by presenting a NorthSouth model with heterogeneous firms and growth. The welfare effects of freer trade may not be as straightforward when simple dynamics are introduced into the analysis, as new static and dynamic effects can be brought up by firm selection, adding to the well-known reduction in prices. Allowing agents to save resources implies that their consuming possibilities can be modified by freer trade, if firm selection affects the activity towards which savings are directed. In the present model, savings are dev
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