Painful Birth of Trade Under Classical Monopolistic Competition

Abstract

In the standard Krugman (1979) non-CES trade model, several asymmetric countries typically lose from increasing trade costs. However, all countries transiently benefit from such increase at the moment of closing trade, under almost-prohibitive trade costs (i.e., near autarky, which is possible only under non-CES preferences). In other words, during trade liberalization the first step from autarky to trade is necessarily harmful. Our explanation rests on market distortion and business destruction effects.

Keywords: Trade gains, monopolistic competition, variable elasticity of substitution, free trade, autarky

JEL Classification: F12, L13, D43