Missing Gains from Trade?

Abstract

In a class of trade models which satisfy a constant elasticity gravity equation, the welfare gains from trade can be computed using the open economy domestic trade share and a constant trade elasticity. The measured welfare gains from trade from this quantitative approach are typically relatively modest. In this paper, we suggest a channel for welfare gains that this quantitative approach typically abstracts from: trade-induced changes in domestic productivity. Using a model of sequential production, in which trade induces a reorganization of production that raises domestic productivity, we show that the welfare gains from trade can become arbitrarily large.