A Theory of Open Trade with Heterogeneous Firms∗

Endowment based economic models with constant returns to scale and perfect competition have been a primary theoretical basis for analyzing political preferences of domestic actors. However, it is well known that such class of model is inadequate in explaining the large volume of intra-industry trade. How do we understand distributive consequences of trade policy of industrialized countries especially when intra-industry trade account for more than 70% of total trade volume of them? In this paper, I offer an alternative political economy model with increasing returns to scale and imperfect competition building on recent trade theories with heterogeneous firms. Specifically, I show that there exist heterogeneous political incentives and capabilities of firms even within a same industry: exporting firms lobby foreign government directly to eliminate trade barriers. In addition, I construct a novel dataset based on lobbying reports in the U.S. and financial statements of firms in global market. I find that domestic firms lobby their own government to reduce trade barriers in foreign countries. This suggests that open trade for sale is at least as important as protection for sale.