Firm heterogeneity, trade, multinationals, and growth: A quantitative evaluation

In this paper I study and quantify the long-run effects of openness to trade and multinational production in a model of endogenous innovation with firm heterogeneity. When trade is liberalized, some multinationals find it more profitable to export and forgo the costs of maintaining capacities in foreign markets. I examine how this trade-off can have long-run effects on growth and welfare. The model emphasizes the importance of firms' ability to access multiple markets in providing incentives to innovate and highlights the role of the quality of technology in international technology spillovers for promoting growth. I find that by shutting down openness to both trade and multinational production with other OECD countries, the US would experience a welfare cost that is equivalent to a 39% drop in consumption, with the dynamic effect accounting for at least 40% of the estimated welfare cost. Since multinationals tend to use relatively high quality technology, trade liberalization alone can lead to an adverse effect on economic growth and consumer welfare by reducing the level of multinational production.