DP16062 Technology, Market Structure and the Gains from Trade
We study the gains from trade in a model with oligopolistic competition, heterogeneous firms and
innovation, and provide a formula to decompose the mechanism. The new insight we provide is that
market concentration can be a welfare-relevant feature of market power above and beyond markup
dispersion. Trade liberalisation increases foreign competition and reduces the number of active firms
in the market, thereby increasing concentration. A more concentrated economy is more efficient due
to increasing returns in production. Moreover, higher concentration produces a scale effect on firms’
incentives to innovate, which increases welfare via productivity improvements. In the calibrated
version of the model we show that a trade-induced increase in concentration contributes substantially
to the gains from trade, mostly via its stimulating effect on innovation. Sizeable gains also come
from the reduction of the inefficiency produced by trade in identical goods; i.e. through a reduction
in reciprocal dumping. Changes in markup dispersion, in contrast, have only negligible effects.
