Factor Market Distortions, International Trade, and Welfare

• Applicant: Professor Dr. Udo Kreickemeier
• Subject Area: Economic Theory ; Economic Policy, Applied Economics
• Term: since 2023
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 518440868

The field of international trade has undergone a revolution over the past two decades. As data about the export activities of individual firms have become available for many countries, it has become obvious that exporting and non-exporting producers are systematically different from each other, and that heterogeneous firm populations with firm-level selection into export markets have important implications for the causes and consequences of international trade. In this project, I want to explore how factor market imperfections, and labour market imperfections in particular, affect the welfare gains from globalisation in this literature adopting the modern, firm-based view on international trade. The link between labour market imperfections and the gains from trade is not well understood in this literature, in stark contrast to the prominent role that the discussion of this very link has had in the traditional literature featuring comparative-advantage trade and perfectly competitive goods markets. My (necessarily speculative) explanation for the lack of urgency in exploring the link between international trade and the distortions created by labour market distortions goes as follows: The key contributions to the new firm-based literature feature aggregate gains from trade despite the presence of such distortions, and therefore the discussion of other model aspects – such as the new distributional effects between workers employed by different firms – took precedence. Still, I argue in this project proposal that there is a high academic payoff to understanding the exact nature of the factor market distortions in the presence of firm heterogeneity, for two reasons. First, I have shown in recently published work that losses from international trade are a possibility in a framework with firm heterogeneity and labour market distortions, similar to the one I want to explore here. This shows that benign welfare effects of trade in these frameworks cannot be taken for granted, which obviously makes it more urgent to understand the welfare dimension of this class of models. And second, only with knowledge of the exact nature of the factor market distortions involved is it possible to make recommendations regarding optimal policy interventions in open economies. In the traditional comparative-advantage world, these recommendations have typically involved leaving international markets open and instead addressing the distortions directly, using domestic policies - an application of the famous targeting principle. Given the skepticism with which the general public often views globalisation it will be immensely valuable, with the help of the results derived in this project, to give similarly well-informed advice in a world that is better described by the modern firm-based view of international trade.

• DFG Programme: Research Grants