CAREER: Welfare Gains from Economic Integration: A Unified Approach

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Abstract Proposal Title: CAREER: Welfare Gains from Economic Integration: A Unified ApproachProposal Number: SES - 1255298Principal Investigator: Arkolakis, KonstantinosThe international trade field has seen a dramatic shift of its research agenda over the past decade. New evidence on the size advantage of exporters has motivated the modeling of firm heterogeneity, resulting in a new analytical framework for international trade. These changes in the field have also lead to a reconsideration of the old pressing question: how large are the gains from economic integration?This proposal outlines a plan to advance the understanding of this question and to begin disseminating this work to the general public. The intellectual merit of the theoretical techniques suggested in this proposal derives from the fact that they maintain a tight link with the data. Thus, they deliver simple and analytically tractable relationships linking barriers to economic integration and openness and, in turn, openness and economic welfare. This theoretical work is complemented by careful quantitative policy analysis. The proposal is composed of four different research projects.Previous assessments of the welfare gains from international trade focus on models with constant markups, thus ignoring the so-called pro-competitive effects of trade. The first project plans to develop a unified framework to analyze the pro-competitive effects of trade in models with variable markups. The main result implies that gains from trade are tightly associated with the degree of price pass-through of firms, a statistic measured independently by many economists.The second project aims to offer a theoretical characterization of the impact of innovation on trade and welfare in a model with variable markups. The goal of this project is to understand the link between innovation and welfare and how pro-competitive effects shape this relationship. For this purpose, the project will assess how different assumptions on the demand and competition structure affect innovation and how trade can intensify innovation and affect welfare.The third project develops an extension of a baseline trade framework that can seamlessly accommodate production of multinational firms and provide a new analytical tool for the understanding of the gains from multinational activity. A component of this project is the development and implementation of a procedure to estimate the model. The end product will be a useful tool for evaluating policies that reduce barriers to trade and multinational activity.The final project will attempt to strengthen the tenuous link between dynamic open economy models and static trade models by developing a multi-country trade model that incorporates the fact that trade adjustment may take time. Using this framework as a basis the proposed project will study the dynamic adjustment of trade to macroeconomic shocks and the welfare implications of the sluggishness of trade responses to these shocks.The proposed research will provide a framework to analyze the main forces that shape the gains from economic integration. It will also provide necessary tools to exploit the rich data on international trade and understand the workings of the world economy. Part of these tools will be integrated to the material of an undergraduate class in International Finance. The simple link between barriers to economic integration and economic welfare derived by this research agenda bypasses the various abstractions of economic theory and makes it a useful tool from a policy perspective. It is thus ideal material for the education of not only future economists but also policy makers and other future leaders in an interdependent world.