The Effects of International Trade on Resource Misallocation: Trade Partner Matters (Replaced by CentER DP 2012-046)

This paper suggests that contingent on the productivity level of the trade partner; international trade may create resource misallocation in less productive countries. It theoretically shows how productivity spillovers induced by trade with more productive countries and heterogeneity in pro- ductivity distributions across sectors lead to asymmetric pro-competitive effects, which in turn result in misallocation. It also presents robust empirical evidence supporting the model predictions by showing that trade with more productive regions as a share of purchasing power parity (PPP) GDP (1) increases economy wide markup variation, (2) raises mean sectoral productivity, and (3) decreases productivity dispersion within 4-digit sectors, only in less productive countries.