Trade and Welfare under Oligopolistic Competition: Reciprocal Dumping or Pro-Competitive Effects?

We study the welfare consequences of reductions in trade costs in a general equilibrium model with symmetric firms and oligopolistic competition. We build on the nested CES model with a continuum of sectors in Atkeson and Burstein (2008), and derive formulas for the welfare consequences of a symmetric reduction in trade costs under different modes of competition (including Cournot and Bertrand competition). The framework collapses to a standard monopolistic competition model with symmetric firms – with an associated Arkolakis et al. (2012) welfare formula – when firms are of negligible size or when the within- and across-sector demand elasticities coincide. When the within-sectoral substitution elasticity goes to infinity, our framework instead converges to a general equilibrium version of the Brander and Krugman (1983) ‘reciprocal dumping’ framework with homogeneous goods. We show that, starting from autarky, symmetric decreases in trade costs may reduce welfare, but only when the within-sectoral elasticity of substitution is high relative to both the cross-sectoral elasticity of substitution and the number of firms. In those cases, welfare is a U-shaped function of trade costs. When the degree of product differentiation within sectors is high enough or when the number of firms is large, welfare is instead monotonically decreasing in trade costs. We explore extensions of the model featuring heterogeneous firms and asymmetric countries.