DP13219 Trade and Domestic Policies under Monopolistic Competition

Author(s): Alessia Campolmi, Harald Fadinger, Chiara Forlati
Publication Date: October 2018
Date Revised: May 2020
Keyword(s): Domestic Policy, efficiency, Heterogeneous Firms, Tariffs and Subsidies, terms of trade, Trade agreements, trade policy
JEL(s): F12, F13, F42
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13219

Should trade agreements also constrain domestic policies? We analyze this question from the perspective of heterogeneous-firm models with monopolistic-competition and multiple sectors. We propose a welfare decomposition based on principles from welfare economics to show that, in a very broad class of models, welfare changes induced by trade and domestic policies can be exactly decomposed into consumption-efficiency, production-efficiency and terms-of-trade effects. Using this decomposition, we compare trade agreements with different degrees of cooperation on domestic policies and show how their performance is affected by the interaction between firm heterogeneity and the relative importance of production efficiency versus terms-of-trade effects.