DP9821 Missing Gains from Trade?

Author(s): Marc J Melitz, Stephen J. Redding
Publication Date: February 2014
Keyword(s): Productivity, Sequential Production, Welfare Gains from Trade
JEL(s): F10, F11, F15
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9821

The theoretical result that there are welfare gains from trade is a central tenet of international economics. In a class of trade models that satisfy a "gravity equation", the welfare gains from trade can be computed using only the open economy domestic trade share and the elasticity of trade with respect to variable trade costs. The measured welfare gains from trade from this quantitative approach are typically relatively modest. In this paper, we suggest a channel for welfare gains that this quantitative approach typically abstracts from: trade-induced changes in domestic productivity. Using a model of sequential production, in which trade induces a reorganization of production that raises domestic productivity, we show that the welfare gains from trade can become arbitrarily large.