Imported inputs and the gains from trade

Abstract

This paper characterizes how plant-level heterogeneity in imported input use affects the aggregate welfare gains from trade. Heterogeneous plants choose a fraction of inputs to source from the lowest cost source country, with the rest purchased domestically. Sourcing more inputs requires higher up-front fixed costs, but reduces variable input costs, so import shares are increasing in plant size. Welfare gains are inversely proportional to the general equilibrium elasticity of the aggregate import share with respect to variable trade costs. A standard bilateral gravity regression underestimates this elasticity by not capturing the effects of trade costs on the input sourcing decision. The welfare gains from trade in the model are therefore lower than the gains implied by a gravity-based estimate of the trade elasticity. When calibrated to Chilean plant-level data, this difference is substantial.