Trade Liberalization, Firm Performance and Labour Market Outcomes in the Developing World: What Can We Learn from Micro-LevelData?

exploitation of scale economies. This is the scale efficiency gain from trade integration.

2.1 Introducing firm heterogeneity

The above results have been derived from a setting with representative firms. Several reasons
suggests, however, to extend the general equilibrium trade models to allow for firm heterogeneity.
In particular:

1) Recent work inter alia by Roberts and Tybout (1996), Olley and Pakes (1996), Aw, Chen and
Roberts (1997) reports evidence of a significant degree of within-industry plant-level heterogeneity.
Hence, allowing for firm heterogeneity may add an important element of realism to the framework
of analysis.

2) Micro-level empirical evidence shows that exporting firms have different characteristics with
respect to non-exporting firms. In particular, the former are larger, more efficient, more skill-
intensive and pay higher wages (Bernard and Jensen, 1997, 1999; Clerides et al., 1998).

3) Most plant-level empirical studies show that trade-induced productivity gains stemming from
the reshuffling of resources between plants with different productivity levels are more relevant than
the scale efficiency gains due to a better exploitation of plant-level scale economies (Tybout, 2001;
Tybout and Westbrook, 1995; Pavcnik, 2002). Therefore, trade models based on representative
firms may miss an important mechanism through which trade reform affects the allocation of
resources, aggregate productivity and income inequality.

One of the most rigorous attempts to embed firm heterogeneity into a general equilibrium trade
model is provided by Melitz (2002), who generalizes Krugman (1980) by dropping the assumption
of symmetric firms² . This model provides new insights on the impact of trade liberalization on the
intra-industry reallocation of resources and can help explain the stylized facts mentioned above.

On the demand side, the model features love for variety, captured by a standard CES util-

²Although Krugman (1980) is a cornerstone of the new trade theory, it is uninteresting (in the absence of firm
heterogeneity) from the standpoint of the effects of trade liberalization on firm performance. The reason is that,
since in this model firms face a constant demand elasticity, trade integration has no effects on firms’ mark-ups, and
on their size and productivity.

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