Income Disparity, Vertical Intra-industry Trade, and Welfare in Integration

This paper constructs an intra-industry trade model with vertical product differentiation and considers a free- trade region where two countries of different income levels to investigate the welfare effects of falling trade costs. It shows that the trade patterns are affected by the income disparity of integrated countries. Moreover, this study finds that the impacts of falling trade costs on the welfare of the two countries are asymmetric depending on the relative income disparity. At some levels of income disparity and some stages of economic integration, there may indeed conflict interests between rich and poor countries with respect to continuing the process of market integration. It implies that a fall in trade costs does not always benefit all countries.