Trade and Domestic Policies in Models with Monopolistic Competition

Speaker:  Alessia Campolmi - Universita' di Verona
  Tuesday, October 15, 2019 at 12:00 PM
We consider unilateral and strategic trade and domestic policies in single and multi-sector versions of
models with CES preferences and monopolistic competition featuring homogeneous (Krugman, 1980) or
heterogeneous firms (Melitz, 2003). We first solve the world-planner problem to identify the efficiency
wedges between the planner and the market allocation. We then derive a common welfare decomposition
in terms of macro variables that incorporates all general-equilibrium effects of trade and domestic policies
and decomposes them into consumption and production-efficiency wedges and terms-of-trade effects. We
show that the Nash equilibrium when both domestic and trade policies are available is characterized by
first-best-level production subsidies that achieve production efficiency, and inefficient import subsidies and export
taxes that aim at improving domestic terms of trade. Since the terms-of-trade externality is the only
beggar-thy-neighbor motive, it remains the only reason for signing trade agreements in this general class of
models. We also show that when trade agreements only limit the strategic use of trade taxes but do not
require coordination of domestic policies, the latter are set ineciently in the Nash equilibrium in order to
manipulate the terms of trade. Moreover, the proportional welfare gains from integrating domestic policies
into trade agreements tend to rise when physical trade barriers fall

Programme Director
Simone Quercia

External reference
Publication date
September 17, 2019