Abstract

This paper formalizes a classic idea that in second-best environments trade can induce welfare losses. In a framework that incorporates distortion wedges into a Melitz model, we
analyze a channel in which trade can reduce allocative efficiency arising from the reallocation of resources. A key aggregate statistics that captures this negative selection is the
gap between input and output shares. We derive sufficient conditions for welfare loss due
to trade under important distributions. Using Chinese manufacturing data for the period
1998-2007, we show that welfare gains and productivity have qualitatively and quantitatively large departures from those predicted by standard models of trade.

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