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  5. Misallocation under Trade Liberalization

Misallocation under Trade Liberalization

  • Yan Bai
  • Keyu Jin
  • Dan Lu
American Economic Review (Forthcoming)

Abstract

This paper formalises 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 that departures from the efficient case (ACR) 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 sizeable negative fiscal externality can potentially offset conventional gains.

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