Ina Simonovska, University of California, Davis and NBER; Federico Etro, University of Venice Ca' Foscari; and Paolo Bertoletti, University of Pavia

International Trade With Indirect Additivity

Bertoletti, Simonovska, and Etro develop a general equilibrium theory of monopolistic competition and trade based on indirectly additive preferences and heterogenous firms. The theory generates a new prediction that markups are independent from destination population but increasing in destination per capita income, as documented by the empirical literature. Trade liberalization delivers incomplete cost pass-through and the key implication is that the welfare gains from trade are significantly lower than those predicted by theories that feature full pass-through; the gap in welfare increases with firms' pricing-to-market elasticities. The researchers outline a tractable parametric specification of indirectly additive preferences that further predicts that small firms grow more during trade liberalization and pass through changes in costs to a higher degree than do large productive ones. The authors estimate the model's parameters to match moments from cross-firm and cross-country data and they quantify the welfare cost of autarky as well as the gains from the proposed Transatlantic Trade and Investment Partnership agreement.