Evaluating Trade Polices on Intermediate goods

In this paper, we introduce a general equilibrium model of international trade that takes into account the endogenous entry and exit of intermediate goods producers and the industry linkages to quantitatively measure the countries welfare gains and losses from the export and import subsidy policies as in China. Our model extends the inter-industry trade model Eaton and Kortum (2002), intra-industry model of Krugman (1980), and firm heterogeneous model of Melitz (2003). Subsidies on intermediate good imports or export subsidies of specific industries affect welfare of countries through direct effects on wages and cost of input bundles of production (labor and intermediate goods), and indirectly through changes in term of trades, and endogenous entries and exits in many industries due to the general equilibrium adjustment of the input-output linkages which are missed in the Eaton and Kortum (2002) environment. We show that the welfare gain from trade depends on the share of domestic goods in intermediate goods. Moreover, the lower elasticities of substitution of intermediate goods than consumption goods magnifies the welfare gain from trade