The rising prominence of intra-industry trade and huge multinationals has transformed the way economists think about the gains from trade. In the past, we focused on gains that stemmed either from endowment differences (wheat for iron ore) or inter-industry comparative advantage (David Ricardo's classic example of cloth for port). Today, we focus on three sources of gains from trade: 1) love-of-variety gains associated with intra-industry trade; 2) allocative efficiency gains associated with shifting labor and capital out of small, less-productive firms and into large, more-productive firms; and 3) productive efficiency gains associated with trade-induced innovation. This paper reviews these three sources of gains from trade both theoretically and empirically. Our empirical evidence will be centered on the experience of Canada following its closer economic integration in 1989 with the United States—the largest example of bilateral intra-industry trade in the world—but we will also describe evidence for other countries.

We extend the theoretical framework in Cuñat and Melitz (2007) to a many-country setup where
countries exhibit different degrees of labor market flexibility. We rely on the insights from a
recent paper by Costinot (2009) to obtain precise predictions about comparative advantage in
this setting: countries with more flexible labor markets specialize in more volatile industries.

Empirical studies of production units within sectors have reported a massive amount of
heterogeneity in various performance measures (most notably, size and productivity). This
heterogeneity, within sectors, matters for theoretical and empirical models of trade. Trade,
or trade liberalization more generally, induces important reallocations between heterogeneous
producers in a sector: the smallest or least productive producers are forced to exit, and market
shares are further reallocated between less productive producers (who do not export) towards
larger, more productive exporters. These reallocations generate a new channel for productivity
and welfare gains from trade.

We develop a simple model of international trade with heterogeneous firms that is consistent with a number of stylized features of the data. In particular, the model predicts positive as well as zero trade flows across pairs of countries, and it allows the number of exporting firms to vary across destination countries. As a result, the impact of trade frictions on trade flows can be decomposed into the intensive and extensive margins, where the former refers to the trade volume per exporter and the latter refers to the number of exporters. This model yields a generalized gravity equation that accounts for the self-selection of firms into export markets and their impact on trade volumes. We then develop a two-stage estimation procedure that uses an equation for selection into trade partners in the first stage and a trade flow equation in the second. We implement this procedure parametrically, semiparametrically, and nonparametrically, showing that in all three cases the estimated effects of trade frictions are similar. Importantly, our method provides estimates of the intensive and extensive margins of trade. We show that traditional estimates are biased and that most of the bias is due not to selection but rather due to the omission of the extensive margin. Moreover, the effect of the number of exporting firms varies across country pairs according to their characteristics. This variation is large and particularly so for trade between developed and less developed countries and between pairs of less developed countries.

We develop a monopolistically competitive model of trade with firm heterogeneity—in terms of productivity differences—and endogenous differences in the “toughness” of competition across markets—in terms of the number and average productivity of competing firms. We analyse how these features vary across markets of different size that are not perfectly integrated through trade; we then study the effects of different trade liberalization policies. In our model, market size and trade affect the toughness of competition, which then feeds back into the selection of heterogeneous producers and exporters in that market. Aggregate productivity and average mark-ups thus respond to both the size of a market and the extent of its integration through trade (larger, more integrated markets exhibit higher productivity and lower mark-ups). Our model remains highly tractable, even when extended to a general framework with multiple asymmetric countries integrated to different extents through asymmetric trade costs. We believe this provides a useful modelling framework that is particularly well suited to the analysis of trade and regional integration policy scenarios in an environment with heterogeneous firms and endogenous mark-ups.

We use a two-country, stochastic, general equilibrium model of international trade and macro-
economic dynamics with monopolistic competition and heterogeneous …rms to explore the role of
entry in the domestic economy and the extensive margin of international trade in the dynamics
of U.S. trade ‡ows over the business cycle. We show that the model can reproduce the evidence
on the cyclicality of U.S. trade and important features of the evidence on the extensive margins
of domestic entry and international trade. Entry in the domestic economy and the implied
di¤erences in the timing of export and import expansions in response to favorable productivity
shocks provide the key mechanism for the model’s ability to explain this range of stylized facts.

This paper studies the role of endogenous producer entry and product creation for monetary policy
analysis and business cycle dynamics in a general equilibrium model with imperfect price adjustment.
Optimal monetary policy stabilizes product prices, but lets the consumer price index vary to accommodate
changes in the number of available products. The free entry condition links the price of equity (the
value of products) with marginal cost and markups, and hence with inflation dynamics. No-arbitrage
between bonds and equity links the expected return on shares, and thus the financing of product creation,
with the return on bonds, affected by monetary policy via interest rate setting. This new channel of
monetary policy transmission through asset prices restores the Taylor Principle in the presence of capital
accumulation (in the form of new production lines) and forward-looking interest rate setting, unlike
in models with traditional physical capital. We also study the implications of endogenous variety for
the New Keynesian Phillips curve and business cycle dynamics more generally, and we document
the effects of technology, deregulation, and monetary policy shocks, as well as the second moment
properties of our model, by means of numerical examples.

We build a dynamic model of …rm-level adjustment to trade liberalization that jointly in-
corporates the main salient features highlighted by recent empirical micro-level studies of …rms
and trade. Our model captures the joint entry, exit, export, and innovation decisions (subject
to sunk costs) of heterogeneous …rms as they adjust to trade liberalization. We characterize
this industrial evolution over its entire transition path to a new steady state with lower trade
costs - starting from the time that trade liberalization is …rst announced (but not necessarily yet
implemented). We rely on numerical methods to solve for these equilibrium paths. In order to
more accurately capture the dynamics of …rm adjustments to trade, we model the sunk nature
of market entry costs for both the domestic and export market - as well as the per-unit and
additional …xed costs of exporting incurred in every period. Firm-level productivity evolves
stochastically, and innovation involves a trade-o¤ between its cost and a return in terms of a
“better”distribution of future productivity draws.
Although the empirical micro-level studies of …rms and export status initially emphasized
the selection e¤ects of more productive …rms into export markets, several recent studies have
highlighted a separate channel for the e¤ects of trade on productivity operating through …rm-
level improvements in productivity. Our model captures both of these channels for the pro-
ductivity enhancing e¤ects of trade - and analyzes their interactions over the adjustment path
to lower trade costs. In particular, we highlight how the relative timing and magnitude of
…rm-level productivity improvements and export market entry decisions are also determined
by non-technological factors such as the timing of trade liberalization announcements and the
speed of liberalization. Under all these di¤erent trade liberalization scenarios (anticipated ver-
sus surprise, gradual versus sudden), we characterize both the distributional e¤ects across …rms
as well as their aggregate e¤ects for industrial performance. We …nd that the anticipation of
upcoming liberalization, and a more gradual path of liberalization (once implemented) induces
…rms to innovate ahead of export market entry.

We study the e¢ ciency properties of a dynamic, stochastic, general equilibrium, macroeco-
nomic model with monopolistic competition and …rm entry subject to sunk costs, a time-to-build
lag, and exogenous risk of …rm destruction. Under inelastic labor supply and linearity of produc-
tion in labor, the market economy is e¢ cient if and only if symmetric, homothetic preferences
are of the C.E.S. form studied by Dixit and Stiglitz (1977). Otherwise, e¢ ciency is restored by
properly designed sales, entry, or asset trade subsidies (or taxes) that induce markup synchro-
nization across time and states, and align the consumer surplus and pro…t destruction e¤ects
of …rm entry. When labor supply is elastic, heterogeneity in markups across consumption and
leisure introduces an additional distortion. E¢ ciency is then restored by subsidizing labor at
a rate equal to the markup in the market for goods. Our results highlight the importance of
preserving the optimal amount of monopoly pro…ts in economies in which …rm entry is costly.
Inducing marginal cost pricing restores e¢ ciency only when the required sales subsidies are
…nanced with the optimal split of lump-sum taxation between households and …rms.

We develop a stochastic, general equilibrium, two-country model of trade and
macroeconomic dynamics. Productivity differs across individual, monopolistically
competitive firms in each country. Firms face a sunk entry cost in the domestic
market and both fixed and per-unit export costs. Only relatively more productive
firms export. Exogenous shocks to aggregate productivity and entry or trade costs
induce firms to enter and exit both their domestic and export markets, thus
altering the composition of consumption baskets across countries over time. In a
world of flexible prices, our model generates endogenously persistent deviations
from PPP that would not exist absent our microeconomic structure with heterogeneous
firms. It provides an endogenous, microfounded explanation for a Harrod-
Balassa-Samuelson effect in response to aggregate productivity differentials and
deregulation. Finally, the model successfully matches several moments of U. S.
and international business cycles.

This paper develops and analyzes a welfare maximizing model of infant industry protection. The
domestic infant industry is competitive and experiences dynamic learning effects that are external to
firms. The competitive foreign industry is mature and produces a good that is an imperfect substitute
for the domestic good. A government planner can protect the infant industry using domestic
production subsidies, tariffs, or quotas in order to maximize domestic welfare over time. As
protection is not always optimal (although the domestic industry experiences a learning externality),
the paper shows how the decision to protect the industry should depend on the industry’s learning
potential, the shape of the learning curve, and the degree of substitutability between domestic and
foreign goods.
Assuming some reasonable restrictions on the flexibility over time of the policy instruments, the
paper subsequently compares the effectiveness of the different instruments. Given such restrictions,
the paper shows that quotas induce higher welfare levels than tariffs. In some cases, the dominance
of the quota is so pronounced that it compensates for any amount of government revenue loss related
to the administration of the quota (including the case of a voluntary export restraint, where no
revenue is collected). In similar cases, the quota may even be preferred to a domestic production
subsidy.