Melitz and Redding on heterogeneous firms and gains from trade

6 June 2013 by

In a recent VoxEU column, Marc Melitz and Stephen Redding describe the logic of Melitz (Ecma, 2003) and Arkolakis, Costinot, and Rodriguez-Clare (AER, 2012). Those should be familiar to Trade Diversion readers (e.g. ACR 2010 wp, Ossa 2012 wp). They then explain their new paper:

In Melitz and Redding (2013b), we show that firm-level responses to trade that generate higher productivity do in fact represent a new source of gains from trade.

  • We start with a model with heterogeneous firms, then compare it to a variant where we eliminate firm differences in productivity while keeping overall industry productivity constant.

We also keep all other model parameters (such as those governing trade costs and demand conditions) constant.

  • This ‘straw man’ model has no reallocations across firms as a result of trade and hence features no productivity response to trade.

Yet it is constructed so as to deliver the same welfare prior to trade liberalisation. We then show that, for any given reduction in trade costs, the model with firm heterogeneity generates higher aggregate welfare gains from trade because it features an additional adjustment margin (the productivity response to trade via reallocations). We also show that these differences are quantitatively substantial, representing up to a few percentage points of GDP. We thus conclude that firm-level responses to trade and the associated productivity changes have important consequences for the aggregate welfare gains from trade.

How can these findings be reconciled with the results obtained by Arkolakis, Costinot, and Rodriguez-Clare (2012)? Their approach compares models that are calibrated to deliver the same domestic trade share and trade elasticity (the sensitivity of aggregate trade to changes in trade costs). In so doing, this approach implicitly makes different assumptions about demand and trade costs conditions across the models that are under comparison (Simonovska and Waugh 2012). By assuming different levels of product differentiation across the models, and assuming different levels of trade costs, it is possible to have the different models predict the same gains from trade – even though they feature different firm-level responses. In contrast, our approach keeps all these ‘structural’ demand and cost conditions constant, and changes only the degree of firm heterogeneity (Melitz and Redding 2013b). This leads to different predictions for the welfare gains from trade.

One potential criticism of our approach is that one can estimate the trade elasticity (the sensitivity of aggregate trade to changes in trade costs) using aggregate trade data only – without requiring any specific assumptions about the firm-level responses to trade. Whatever assumptions are made about those firm-level responses (and the demand and trade-cost conditions), they should then be constructed so as to match that estimated aggregate elasticity. However, recent empirical work has shown that those underlying assumptions radically affect the measurement of the aggregate trade elasticity, and that this trade elasticity varies widely across sectors, countries, and the nature of the change in trade costs (see for example Helpman et al. 2008, Ossa 2012, and Simonovska and Waugh 2012). There is thus no single empirical trade-elasticity parameter that can be held constant across those different models.

Given the lack of a touchstone set of elasticities, we favour our approach to measuring the gains from trade arising from different models; one that maintains the same assumptions about demand and trade costs conditions across those models.

Follow @TradeDiversion on Twitter

15 May 2013 by

You’ve no doubt noticed that recently I’ve only been posting once or twice per month. However, I am regularly sharing links and brief comments on Twitter, so you should follow @TradeDiversion. Recently on the Twitter feed (but not the blog):

AFT on Railroads of the Raj

13 May 2013 by

A Fine Theorem has a nice write-up of Dave Donaldson’s Railroads of the Raj. He’s put in more effort than I did when writing it up in 2009.

Harry Johnson on Staffan Linder

29 April 2013 by

I haven’t seen a book review like this in some time. Harry Johnson didn’t hold back while expressing his opinion of Linder (1961). This is the closing paragraph of his rather blunt five-page review:

In summary, this is at once an ambitious, provocative, and provoking book-ambitious in the breadth and depth of the problems in trade theory it propounds and seeks to solve, provocative in the hypotheses it propounds, and provoking on account both of the perverse misinterpretations of existing theory that the author produces to support his claims to novelty and of the careless botch he makes of the exposition of his own alternative theories. The result is a volume that ought to be read by specialists looking for seminal ideas and interesting research problems,but that cannot be recommended for use by students insufficiently trained to be alert to the substitution of emotive debating points for reasoned argument and of irrelevance for logical analysis. [Economica, 1964]

KAL on current trade politics

14 February 2013 by

The Chinese government didn’t allocate its MFA quotas efficiently

15 January 2013 by

Amit Khandelwal, Pete Schott, and Shang-Jin Wei have a nice VoxEU column describing their forthcoming AER article on Chinese textile exports under the Multifibre Arrangementquotas. In short, inefficiently implemented policy can substantially amplify the economic distortions introduced by trade barriers:

If trade barriers are managed by inefficient institutions, trade liberalization can lead to greater-than-expected gains. We examine Chinese textile and clothing exports before and after the elimination of externally imposed export quotas. Both the surge in export volume and the decline in export prices following quota removal are driven by net entry. This outcome is inconsistent with a model in which quotas are allocated based on firm productivity, implying misallocation of resources. Removing this misallocation accounts for a substantial share of the overall gain in productivity associated with quota removal.

Mead and Drezner on EU-US trade prospects

11 January 2013 by

Alan Beattie and Joshua Chaffin in the FT:

This month, a working group led by EU trade commissioner Karel De Gucht and US trade representative Ron Kirk is likely to suggest starting formal negotiations…

“The stars are almost aligned,” says Greg Slater, director of global trade policy at Intel, the chipmaker. The US and EU “have the opportunity to try to set the gold standard” in areas such as intellectual property protection, he says, which emerging markets like China and India would then have to respect.

Yet the deal faces complex challenges. Trade policy has moved from focusing on simple import tariffs on goods – already low for most transatlantic commerce – to often complicated “behind-the-border” domestic regulation. Technical standards, not tariffs, are the biggest barriers to integrating fast-growing US and European markets such as pharmaceuticals, medical services and advanced electronics…

“The aim in many instances is not to drive immediately for full regulatory convergence but to try to make sure that regulators on both sides of the Atlantic are making decisions with their eyes wide open,” says Sean Heather, vice-president of the [US Chamber of Commerce] chamber’s centre for global regulation. “The idea that negotiators are going to sit down with a big list and say: ‘We’ll give you that if you give us this,’ is probably not going to work for most regulations.”

Yet even agreeing an approach on convergence confronts bureaucratic and philosophical barriers. Regulation in both economies is frequently divided among different agencies, some jealous of their independence and unused to considering international implications.

Walter Russell Mead:

A U.S.-EU trade deal is essentially a way to ignore countries like Brazil and India while crafting rules that will govern some of the high-tech industries and information-based services that play a growing role in US-EU trade. Once those rules are set, the BRICs will be hard pressed to avoid signing onto them later on down the road.

Dan Drezner:

Two things have changed.  First, the traditional method of multilateral trade liberalization has died.  Second, while both the US and EU are major trading states, they’re not quite as pivotal as they used to be.  Ironically, it’s their declining (though still appreciable) importance in global trade that makes a US-EU agreement feasible now.  The BRIC economies are now sufficiently large that a transatlantic trade deal doesn’t seem like an existential threat.

And here’s Richard Baldwin, “Regulatory Protectionism, Developing Nations, and a Two-Tier World Trade System ,” Brookings Trade Forum: 2000.

John McLaren – International Trade

5 January 2013 by

I haven’t seen the inside of John McLaren’s new international trade textbook, but I really like the cover:

Trade at VoxEU

23 December 2012 by

Some recent VoxEU columns:

  • In Belgian firm-level data, a smaller percentage of services-producing firms export than goods-producing firms. Exporting entry and exit rates are higher in services than goods.
  • Richard Baldwin says that vertical specialization requires global trade governance sufficiently distinct from existing WTO practices that it requires a new organization.
  • An optimistic take on the Trans-Pacific Partnership and proposed EU-US trade deal.

Trade JMPs (2012-2013)

9 December 2012 by

Who’s on the job market this year with a paper on international trade? As usual, I focus on trade papers, thereby neglecting international finance and open-economy macro papers and trade economists working in other fields. I’m a bit late this year, so please help me by identifying more candidates in the comments section. [Update: Thanks to Rm and Bernardo for their comments.]

  • Assaf Zimring (Stanford) – Gains from Trade: Lessons from The 2007-2010 Gaza Blockade
  • Qi Zhang (LSE) – Income Distribution and the Price Level: The Balassa-Samuelson Relationship Re-considered
  • Hongsong Zhang (PSU) –  Static and Dynamic Gains from Importing Intermediate Inputs: Theory and Evidence
  • Christopher Tonetti (NYU) – Equilibrium Technology Diffusion, Trade, and Growth
  • Felix Tintelnot (PSU) – Global Production with Export Platforms
  • Tomasz Swiecki (Princeton) – Intersectoral Distortions, Structural Change and the Welfare Gains from Trade
  • Joseph Shapiro (MIT) – Trade, CO₂, and the Environment
  • Fernando Perez Cervantes (Chicago) – Railroads and Economic Growth: A Trade Policy Approach
  • Dan Murphy (Michigan) – Why are Goods and Services more Expensive in Rich Countries? Demand Complementarities and Cross-Country Price Differences
  • Julien Martin (Louvain) – The Few Leading the Many: Foreign Affiliates and Business Cycle Comovement
  • Yanping Liu (PSU) – Capital Adjustment Costs: Implications for Domestic and Export Sales Dynamics
  • Fernando Leibovici (NYU) – Financial Development and International Trade
  • Attakrit Leckcivilize (LSE) – The Impact of Supply Chain Disruptions: Evidence from the Japanese Tsunami
  • Sarah Kroeger (BU) – The Contribution of Offshoring to the Convexification of the U.S. Wage Distribution
  • James Key (PSU) – Priors and Posteriors: Implications for Exporters
  • Leo Karasik (U Toronto) – The Role of Regional Portfolios in the Affiliate Location Decision of Multinational Firms
  • Fadi Hassan (LSE) – The Price of Development
  • John Feddersen (Oxford) – Pollution Havens: Does Third Country Environmental Policy Matter?
  • Benjamin Faber (LSE) – Trade Liberalization, the Price of Quality, and Inequality: Evidence from Mexican Store Prices
  • Javier Cravino (UCLA) – Exchange Rates, Aggregate Productivity and the Currency of Invoicing of International Trade
  • Bo-Young Choi (UC Davis) – The Differential Effect of Trade Liberalization When Buyer Power is Present
  • Samuel Bazzi (UCSD) – Wealth Heterogeneity, Income Shocks, and International Migration: Theory and Evidence from Indonesia
  • Jose Asturias (Minnesota) – Endogenous Transportation Costs


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