The Role of Trade in Economic Development

This chapter (to appear in the forthcoming Handbook of International Economics, Vol. 5) develops a framework with which to interpret and survey answers to the question: how does increased openness affect aggregate welfare in a typical developing country? We decompose answers into four mechanisms: (i) an effect akin to technological progress that is purely mechanical; (ii) an effect on factoral terms of trade; (iii) a distortion revenue effect that exacerbates or mitigates the consequences of domestic distortions; and (iv) an effect of trade on the magnitude of those distortions themselves. Our focus lies in the last two mechanisms as these are especially important for the study of low-income settings where domestic distortions are thought to be rife. Throughout, we provide both a review of existing work on these topics and quantitative calculations that aim to gauge the magnitudes involved in a global model that is calibrated to match firm- and industry-level data on trade flows, production techniques, and a host of distortions (tariffs, other taxes, markups, bribes, theft, credit constraints, contracting failures, labor regulations, and public utility provision) that have featured in the literature.