Grounded by Gravity: A Well-Behaved Trade Model with Industry-Level Economies of Scale

Abstract

We propose a model to study the role of industry-level external economies of scale in open economies. If the elasticity governing the strength of external economies is below the inverse of the trade elasticity in each industry, then specialization under frictionless trade is consistent with comparative advantage, the model is tractable even with trade frictions, and all countries gain from trade. External economies lower gains from trade except if the country specializes in industries with high scale economies, and they amplify the gains from further trade liberalization except if it leads to specialization in industries with low scale economies. (JEL D24, F11, F12, F13)