DP13976 Misallocation Under Trade Liberalization

Author(s):	Keyu Jin
Publication Date:	September 2019
Keyword(s):	Capital and labor wedges, Gains from trade, industrial policy, Misallocation, trade liberalization
JEL(s):	E23, F12, F14, F63, L25, O47
Programme Areas:	International Trade and Regional Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=13976

This paper incorporates firm-level distortions into a Melitz model and characterizes welfare under misallocation. We derive an analogue to the well-known ACR result in an economy with distortions. We highlight a channel through which trade can reduce welfare by exacerbating misallocation. A key statistic to infer welfare is the gap between input and output shares. Using Chinese manufacturing data for quantitative analysis, we show that trade integration can lead to a 18% welfare loss coming from a reduction in allocative efficiency. The overall gains to trade is substantially smaller than implied by standard calculations.