Increasing returns, monopolistic competition, and international trade: Revisiting gains from trade

We study the canonical Krugman (1979) trade model with non-CES preferences that yield autarky at finite trade costs. We prove a non-monotone impact of gradual trade liberalization. At first, near autarky, emerging trade reduces world welfare, while at free trade it becomes large enough to be beneficial (Krugman's result). This non-monotonicity persists under heterogenous firms. The harmful small-scale trade is explained by variable markups and underpriced imports, which become socially excessive. Unlike protectionists, we argue that “liberalization should go far”. On the other hand, we show that anti-dumping measures can be viewed as a remedy for the aforementioned imports distortion.