Endogenous Trade Policy with Heterogeneous Firms

The present paper modifies the \Protection for Sale" model of Grossman and Helpman (1994) to account for heterogeneous firms lobbying for non-tariff barriers to trade, such as technical standards or certification requirements. They raise the fixed costs of market access for both domestic producers and foreign exporters, force the least efficient firms to exit and shift profits to the most efficient firms. Non-tariff barriers to trade shift profits both within and across countries, but not necessarily to the country in which firms are more productive on average. They decrease social welfare as they reduce competition and product variety, but may nevertheless be implemented if only the largest domestic firms lobby the government. When variable trade costs fall or foreign firms become relatively more competitive, the potential for profit shifting and hence non-tariff barriers to trade decrease. The paper also analyzes the case of international trade negotiations, and it addresses the issue of endogenous lobby formation.