Misallocation Under Trade Liberalization
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 reallocation loss due to trade under important distributions. Using Chinese manufacturing data, we show that this reallocation term is significantly negative, largely offsetting conventional gains to trade.
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