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Misallocation under trade liberalization

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  • Bai, Yan
  • Jin, Keyu
  • Lu, Dan

Abstract

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.

Suggested Citation

  • Bai, Yan & Jin, Keyu & Lu, Dan, 2024. "Misallocation under trade liberalization," LSE Research Online Documents on Economics 124221, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:124221
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • L60 - Industrial Organization - - Industry Studies: Manufacturing - - - General
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations
    • P31 - Political Economy and Comparative Economic Systems - - Socialist Institutions and Their Transitions - - - Socialist Enterprises and Their Transitions
    • P33 - Political Economy and Comparative Economic Systems - - Socialist Institutions and Their Transitions - - - International Trade, Finance, Investment, Relations, and Aid

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