Intersectoral Distortions, Structural Change and the Welfare Gains from Trade

How large are the welfare gains from trade when factors are misallocated due to domestic distortions? In this paper I provide a quantitative answer to this question by incorporating distortions to the allocation of labor across broad sectors into a model of structural change and Ricardian trade. Calibrating the model using 36 years of data for a diverse set of countries I find that (1) gains from trade for net exporters of agricultural goods are overstated in models that abstract from intersectoral distortions since in those countries trade tends to exacerbate the effect of domestic frictions; (2) due to distortions developing countries have a strong unilateral incentive to protect their manufacturing sector from foreign competition and that yielding to such protectionist sentiments would negatively affect other poor countries; and (3), mitigating domestic frictions has a much larger potential payoff for poor countries when they are open to international trade. JEL Numbers: F16, F40, O11, O19, Q17.