DP4635 Trade Liberalization with Heterogenous Firms

Author(s): Richard Baldwin , Rikard Forslid

Publication Date: September 2004

Keyword(s): trade liberalization , heterogeneous firms , anti-variety effect , Krugman variety effect

JEL(s): H32 , P16

Programme Areas: International Trade and Regional Economics

Link to this Page: www.cepr.org/pubs/dps/DP4635.asp

This Paper details the positive and normative effects of reciprocal trade liberalization when firms have endogenously determined, heterogeneous productivity levels. We show that trade liberalization leads to: (i) an anti-variety effect (the number of varieties consumed drops) in contrast to the well-known Krugman variety effect; and (ii) a Stolper-Samuelson like result on factor rewards. We decompose the welfare impact into four partial effects. Three of these are unique to the model, namely, the Melitz anti-variety effect, the Melitz productivity effect, and the MacDonalisation effect. We show that the first effect tends to lower welfare while the other two tend to raise it. Overall, the four effects imply that the representative gains from trade liberalization. If we identify factor ownership with particular classes of consumers, we can say that freer trade implies unambiguous welfare gains for labourers and export-firm owners. Other firm owners gain if and only if spending on manufactured varieties is sufficiently high.