Gains From Trade with Heterogeneous Households - Gizem Kutlu

Abstract: In this paper, I investigate the distributional consequences of international trade within countries by taking into account different dimensions of heterogeneity across households and allowing them to interact with each other. I consider the welfare consequences of differences between households’ expenditures, the effect of trade costs on wages, and the impact of these costs on households’ intertemporal consumption-saving decisions. I develop a two-country, multisector dynamic model of trade with households that are heterogeneous in wealth, earning abilities, and education (skill) level. The model features nonhomothetic preferences, idiosyncratic income shocks, endogenous consumption-saving decisions, and capital-skill complementarity. I calibrate the model to the United States and Mexico to analyze the distributional implications of the North American Free Trade Agreement. The results imply that considering three dimensions of heterogeneity—wealth, income, and education—and the interaction between the mechanisms they generate is crucial in order to measure gains from trade accurately. I find that in both countries, an unanticipated permanent elimination of import tariffs relatively favors the poor within each education level. However, the gap between the gains of the poor and the rich is larger for college graduates compared to non-college workers. In addition, I show that although college graduates experience larger gains than noncollege workers at the same wealth level, poor non-college workers gain more than rich college graduates. Finally, I find that an anticipated permanent elimination of tariffs results in lower gains than an unanticipated fall, especially for the poor