Trade and Domestic Policies Under Monopolistic Competition

94 Pages Posted: 8 Oct 2018 Last revised: 22 Sep 2021

See all articles by Alessia Campolmi

Alessia Campolmi

University of Verona

Harald Fadinger

University of Mannheim

Chiara Forlati

University of Southampton - Department of Economics

Date Written: October 2018

Abstract

Should trade agreements also constrain domestic policies? We analyze this question from the perspective of models with monopolistic competition, potentially heterogeneous firms, and multiple sectors. We propose a welfare decomposition based on principles from welfare economics to show that, in a broad class of models, welfare changes induced by trade and domestic policies can be exactly decomposed into consumption-efficiency, production-efficiency and terms-of-trade effects. Using this decomposition, we compare trade agreements with different degrees of integration and show how their performance is affected by the interaction between firm heterogeneity and the relative importance of production efficiency versus terms-of-trade effects. We consider several forms of shallow trade agreements, modeled according to GATT-WTO rules, and show that they are not sufficient to achieve the full benefits of globalization that can be obtained with a deep trade agreement coordinating both trade and domestic policies. Moreover, the distortions arising from uncoordinated domestic policies under shallow free trade agreements increase when physical trade costs fall, thus raising the benefits of deep trade integration.

Keywords: Domestic Policy, efficiency, Heterogeneous Firms, Tariffs and Subsidies, terms of trade, Trade agreements, trade policy

JEL Classification: F12, F13, F42

Suggested Citation

Campolmi, Alessia and Fadinger, Harald and Forlati, Chiara, Trade and Domestic Policies Under Monopolistic Competition (October 2018). CEPR Discussion Paper No. DP13219, Available at SSRN: https://ssrn.com/abstract=3262544

Alessia Campolmi (Contact Author)

University of Verona ( email )

University of Verona
via Cantarane 24
Verona, 37129
Italy

Harald Fadinger

University of Mannheim ( email )

Department of Economics
L7 3-5
Mannheim, 68131
Germany

Chiara Forlati

University of Southampton - Department of Economics ( email )

University of Southampton
Murray Building, Salisbury Rd
Southampton UK, SO17 1BJ
United Kingdom

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