Trade liberalisation and agglomeration with firm heterogeneity: Forward and backward linkages

Abstract

This paper studies the impact of trade cost reductions on the geographical concentration of manufacturing in the presence of intermediate input linkages, firm heterogeneity and fixed export costs. The presence of non-exporting firms in this Melitz-like model hampers full agglomeration by weakening the forward and backward linkages and fortifying market-crowding effect. Gradual trade liberalisation causes gradual agglomeration rather than the catastrophic agglomeration that economic geography models have long suggested. Also, trade liberalisation produces divergent welfare effects with the periphery losing and the core gaining; even costless trade fails to equalise welfare in the core and periphery due to non-exported intermediate inputs.