Trade, Productivity Improvements and Welfare: An Endogenous Market Structure Framework

Abstract

In this paper, I investigate the welfare effects that developed countries experience after productivity improvements occur in their emerging trading partners, using a two-country model featuring pro-competitive effects of trade and asymmetries in technology. I model the technology advantage of the developed country, assuming that the productivity distribution its firms draw from stochastically dominates that of the emerging country. Calibrated to match aggregate and firm level statistics of the US economy, the model predicts that the country with better technology has a higher productivity cut-off level, higher average productivity and higher welfare. Productivity improvements in the emerging country generate selection and raise welfare everywhere, with both the selection effect and the positive welfare effect being stronger in the emerging country. Finally, trade liberalization is associated with more selection and higher welfare in both the developed and the emerging country.

Keywords: Asymmetric Countries, Productivity Improvements, Welfare, Endogenous Market Structure

JEL Classification: F12, F62, O33, I31