Trade Liberalisation with Multinational Firms: Effects on Welfare and Intra-Industry Trade

In this paper, we model trade liberalisation as an endogenous process and shed new light on how economic fundamentals like endowments and technology affect potential gains, the welfare effects of liberalisation and its consequences for intra-industry trade. We construct a general equilibrium model of trade and (tariff-jumping) MNEs and augment this by numerical simulation experiments which allow us to abandon some simplifying assumptions. Our insights regarding the welfare effects of tariff reductions motivate an empirical investigation of the determinants of free trade areas, which accounts for factor endowments, trade costs, and investment costs. Further, we study the consequences of trade liberalisation for intra-industry trade shares in the presence of MNEs. We find that formation of free trade areas has significant trade composition effects, with important implications for intra-industry trade.