Tradability, Productivity, and Understanding International Economic Integration

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  • 1 January 2005
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      • Published in RePEc
Abstract
This paper develops a two-country macro model with endogenous tradability to study features ofinternational economic integration. Recent episodes of integration in Europe and North Americasuggest some surprising observations: while quantities of trade have increased significantly,especially along the extensive margin of goods previously not traded, price dispersion has notdecreased and may even have increased. These observations challenge the usual understanding ofintegration in the literature. We propose a way of reconciling these price and quantityobservations in a macroeconomic model where the decision of heterogeneous firms to tradeinternationally is endogenous. Trade is shaped both by the nature of heterogeneity -- trade costsversus productivity -- and by the nature of trade policies -- cuts in fixed costs versus cuts in perunit costs like tariffs. For example, in contrast to tariff cuts, trade policies that work mainly bylowering various fixed costs of trade may have large effects on entry decisions at the extensivemargin without having direct effects on price-setting decisions. Whether this entry raises orlowers price dispersion depends on the type of heterogeneity that distinguishes the new entrantsfrom incumbent traders.
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