The availability of rich firm-level data has led researchers to uncover new evidence on the effects of trade liberalization. First, trade openness forces the least productive firms to exit the market; secondly, it induces surviving firms to increase their innovation efforts; thirdly, it increases the degree of product market competition. In this paper, we propose a model aimed at providing a coherent interpretation of these findings, and use it to assess the role of firm selection in shaping the aggregate welfare gains from trade. We introduce firm heterogeneity into an innovation-driven growth model where incumbent firms operating in oligopolistic industries perform cost-reducing innovation. In this environment, trade liberalization leads to lower markups level and dispersion, tougher firm selection, and more innovation. Calibrated to match US aggregate and firm-level statistics, the model predicts that moving from a 13% variable trade costs to free trade increases the stationary annual rate of productivity growth from 1:19 to 1:29% and increases welfare by about 3% of steady state consumption. Selection accounts for about 1=4th of the overall growth increase and 2=5th of the welfare gains from trade.
Download the paper in PDF format
Giammario Impullitti and Omar Licandro
View all School of Economics discussion papers | View all School of Economics featured discussion papers
Sir Clive Granger BuildingUniversity of NottinghamUniversity Park Nottingham, NG7 2RD
Contact us