Misallocation Under Trade Liberalization

Yan Bai, Keyu Jin, Dan Lu

NBER Working Paper No. 26188
Issued in August 2019, Revised in April 2020
NBER Program(s):International Finance and Macroeconomics, International Trade and Investment

This paper formalizes a classic idea that in second-best environments trade can induce welfare losses. In a framework that incorporates distortion wedges into a Melitz model, we analyze a channel in which trade can reduce allocative efficiency arising from the reallocation of resources. A key aggregate statistics that captures this negative selection is the gap between input and output shares. We derive sufficient conditions for welfare loss due to trade under important distributions. Using Chinese manufacturing data for the period 1998-2007, we show that welfare gains and productivity have qualitatively and quantitatively large departures from those predicted by standard models of trade.

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Acknowledgments

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Document Object Identifier (DOI): 10.3386/w26188