NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

International Trade with Indirect Additivity

Paolo Bertoletti, Federico Etro, Ina Simonovska

NBER Working Paper No. 21984
Issued in February 2016
NBER Program(s):Development Economics, Economic Fluctuations and Growth, International Finance and Macroeconomics, Industrial Organization, International Trade and Investment

We develop a general equilibrium model of monopolistic competition and trade based on indirectly additive preferences and heterogenous firms. It generates markups independent from destination population but increasing in destination per capita income, as documented empirically. Trade liberalization delivers an increase in consumed variety and incomplete cost pass-through. This leads to welfare gains that can be much lower than those predicted by comparable models with different preferences. We introduce a tractable utility function that further predicts that small firms grow more during trade liberalization and pass through cost changes more than do large firms. Once we estimate the model to match moments from cross-firm and cross-country data we (i) find quantitatively large differences in the welfare gains from trade relative to models based on homothetic preferences, and (ii) evaluate the gains and losses from the Transatlantic Trade and Investment Partnership agreement.

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Document Object Identifier (DOI): 10.3386/w21984

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