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.