Globalization and Individual Gains from Trade

September 27, 2009

by Kristian Behrens and Yasusada Murata

We analyze the impact of globalization on individual gains from trade in a general equilibrium model of  monopolistic competition featuring product diversity, procompetitive effects and income heterogeneity between and within countries. We show that, although trade reduces markups in both countries, its impact on variety depends on their relative position in the world income distribution: product diversity in the lower income country always expands, while that in the higher income country may shrink. When the latter occurs, the richer consumers in the higher income country may lose from trade because the relative importance of variety versus quantity increases with income. We illustrate this effect using data on GDP per capita and population for 186 countries, as well as parameter estimates for domestic income distributions. Our results suggest that U.S. trade with countries of similar GDP per capita makes all agents in both countries better off, whereas trade with countries having lower GDP per capita may adversely affect up to 11% of the U.S. population.

In a framework that allows decomposition of gains from trade into those due to product diversity and due to pro-competition effects, Behrens and Murata show that product diversity always expands with trade in poor countries (may shrink in rich countries), and that trade always improves competition. Consequently, everyone in poor countries must gain, while there may be situations when some rich citizens of rich countries lose from trade because they value loss of diversity more than gain in efficiency.

It would be interesting to see how the results change if comparative advantage and two productive factors are introduced into the model’s framework. It would also be interesting to get a sense of the extent to which assumed variable elasticity of substitution (with income) is an empirically relevant modeling strategy.

The NEP-OPM Blog

September 27, 2009

This blog is an experiment to explore the feasibility of scientific discussion on an Economics blog. NEP-OPM disseminates every week new working papers in the field of Open Macroeconomics. Among them, the NEP-OPM editor selects one to be discussed. Everyone is invited to comment. Try to stay civil, or your comments will be removed. And encourage others to read or join in the discussion.