Comparison of Welfare Gains in the Armington, Krugman and Melitz Models : Insights from a Structural Gravity Approach
How large are the estimated gains from trade from a reduction in trade costs in the heterogeneous firms Melitz (M) model compared with the Armington (A) and Krugman (K) models? Surprisingly little is known beyond the one-sector model. This paper an...
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| Language: | English |
| Published: |
World Bank, Washington, DC
2018
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| Online Access: | http://documents.worldbank.org/curated/en/326641535461066421/Comparison-of-Welfare-Gains-in-the-Armington-Krugman-and-Melitz-Models-Insights-from-a-Structural-Gravity-Approach http://hdl.handle.net/10986/30322 |
| Summary: | How large are the estimated gains from
trade from a reduction in trade costs in the heterogeneous
firms Melitz (M) model compared with the Armington (A) and
Krugman (K) models? Surprisingly little is known beyond the
one-sector model. This paper analyzes this question using a
global trade model that contains ten regions and various
numbers of sectors (1-10). Following Arkolakis et al.
(2012), the analysis holds the local trade response constant
across the model comparisons based on a structural gravity
estimate. Various model features and scenarios are
introduced that are important to real economies, almost none
of which has been examined across the three market
structures with a constant trade response. In response to
global reductions in iceberg trade costs, in all the
multi-sector models, the ranking of global welfare gains is
Melitz > Krugman > Armington; and the Krugman model
captures between 75 and 95 percent on the additional gains
above the Armington model that are estimated by the Melitz
model. However, for individual regions, there are numerous
cases of reversed welfare rankings. i.e., Melitz <
Krugman < Armington. For unilateral increases in tariffs,
welfare gains are typically estimated with the Armington
model, but welfare losses with monopolistic competition
models. The paper constructs a multi-sector Feenstra ratio
for the Dixit-Stiglitz variety externality and calculates
changes in the terms-of-trade. These parameters provide
economically intuitive explanations of the general pattern
of results and exceptions. The paper concludes that gains
from the reduction of trade costs for the world are: Melitz
> Krugman > Armington. For individual regions,
however, the welfare ranking of the Armington, Krugman and
Melitz market structures is model, data, parameter and
scenario dependent. The results highlight the need for data
and structural considerations in policy analysis. |
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