“Misallocation Under Trade Liberalization” by Dr. Dan LU
University of Rochester
What is the impact of trade liberalization on economies with sizeable distortions? A Melitz model incorporating firm-level wedges shows that trade liberalization can exacerbate rather than improve resource allocation, causing a decline rather than a rise in TFP. We derive a theoretical decomposition of the various channels through which distortions impact the effects of trade, and show that trade can engender welfare losses. A quantitative assessment using Chinese manufacturing data shows that there is a TFP loss in association with trade liberalization, and a significantly smaller gains to trade than what is implied by standard formulations. Moreover, using only aggregate statistics to measure gains to trade apropos the ACR formula would lead to markedly different predictions.