Globalization and the gains from variety : the case of a small open economy

Book excerpt: Since the pioneering work of Krugman (1980) economists try to quantify thewelfare gains from an increase in traded variety. The seminal work of Feenstra(1994) and its application to the U.S. of Broda and Weinstein (2006) allowed thisquantification for the first time using highly disaggregated trade data. In thispaper it is argued that size and openness of a country are important factors indetermining these welfare gains. The gains from traded variety of a small openeconomy are calculated and compared to those of the U.S.; the differencesbetween the countries are then analysed carefully. To achieve this, themethodology of Feenstra (1994) is extended. While the Armington definition of avariety forces the researcher to assume no growth at the extensive margin, in thispaper the Feenstra ratios are reinterpreted in a way that allows for full growth atthe extensive margin. The resulting two polar cases will influence the countrycomparison with respect to the gains from variety: Depending on how muchgrowth at the extensive margin a researcher is willing to assume, the relative gainsfrom variety of a small open economy compared to a larger economy like theU.S. are changed. It is also argued that this result may hold generally for othersmall and large OECD economies.