Misallocation under Trade Liberalization

This paper formalizes a classic idea that in second-best environments trade can induce welfare losses: incremental income losses from distortions can outweigh trade gains. In a Melitz model with distortionary taxes, we derive sufficient statistics for welfare gains/losses and show departures from th...

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Bibliographic Details
Published in:The American economic review 2024-07, Vol.114 (7), p.1949-1985
Main Authors: Bai, Yan, Jin, Keyu, Lu, Dan
Format: Article
Language:English
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Summary:This paper formalizes a classic idea that in second-best environments trade can induce welfare losses: incremental income losses from distortions can outweigh trade gains. In a Melitz model with distortionary taxes, we derive sufficient statistics for welfare gains/losses and show departures from the efficient case (Arkolakis, Costinot, and Rodríguez-Clare 2012) can be captured by the gap between an input and output share and domestic extensive margin elasticities. The loss reflects an endogenous selection of more subsidized firms into exporting. Using Chinese manufacturing data in 2005 and model-inferred firm-level distortions, we demonstrate that a sizable negative fiscal externality can potentially offset conventional gains. (JEL D22, F14, H25, L60, O19, P31, P33)
ISSN:0002-8282
1944-7981
DOI:10.1257/aer.20200596