Profit Shifting, Import and Export Markups, and the Gains from Trade

This paper develops a multi-sector, multi-country model of international trade and profit shifting which embeds imperfect product markets and markups into Eaton and Kortum (2002)'s Ricardian trade model. Within a country, producers in different sectors face different demand elasticities, and therefore, charge different markups. Moreover, markup distributions for both imports and exports are allowed to vary across countries. We first show theoretically that the gains from trade can depend crucially on the markup distribution for imported goods versus that for exported goods. To then bring the model to the data and to quantify the markup distributions for imports and exports, we estimate both trade elasticities and a rich set of country- and industry-specific import demand elasticities for over 120,000 distinct sector-country pairs and incorporate them into our structural model. We find that cross-country heterogeneities in the markup distribution for exports and imports are an important determinant of the gains from trade and especially the welfare losses from tariffs; By taking markups into account, these losses are up to three times larger (smaller) for net exporters (importers) of high-markup products. Finally, we apply our model to the recent U.S.-China trade war and show that the U.S. experienced significantly higher welfare losses from the tariff war once markups and profit shifting are taken into account, while China slightly benefited overall.