A general equilibrium analysis of the Eaton and Kortum (2002) trade model

This thesis examines the national welfare consequences of trade liberalization, in the form of changes to import tariff rates, within the Eaton and Kortum (2002) trade model, a 2-sector Ricardian trade model with a novel stochastic specification of national productivity. We first provide a thorough characterization of the general equilibria found in both the mobile labor and immobile labor variants of the Eaton and Kortum (2002) trade model, followed by proofs of the existence and uniqueness of these equilibria. Given the multiple sectors of trade specified in Eaton and Kortum (2002), it is possible for countries to experience trade surpluses in one particular sector of trade, so long as they are balanced by deficits in the other sectors. Welfare consequences of sector specific trade liberalization measures depends on the sectoral trade balance. This thesis provides a characterization of the pattern of national trade balances in the Eaton and Kortum (2002) trade model, and demonstrates that when some regularity conditions are met, countries can be totally ordered by the number of other countries with which they enjoy trade surpluses. Having established the features of the general equilibrium of the Eaton and Kortum trade model, the thesis next examines how the establishment of preferential trade agreements influences national welfare within the context of the model. We do so by consider the elemental case of a country unilaterally changing the tariff rate imposed on imports from some other country, and mathematically describe the amplification process that propogates, via trade in intermediate goods, the initial price shock resulting from the unilateral tariff change to the rest of the world. It was found that in the mobile labor variant of the Eaton and Kortum (2002) model, any country increasing import tariff rates would increase prices in every country, causing all countries to substitute away from imports towards domestic suppliers. Furthermore, global free trade agreements would not be stable within this context, as every country has an incentive to unilaterally deviate from such arrangements by imposing import tariffs. It was also found that rules punishing such unilateral deviations by allowing punitive import tariffs to be imposed against the offending country would be ineffective in removing the incentives for deviation.