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Processing Trade, Firm Heterogeneity and Export Behavior of Chinese Firms

In this paper, I have incorporated pure exporters into an asymmetric two-country general equilibrium model by Melitz (2003) to explain trade performance and export patterns in China. This model captures the coexistence of pure exporters, non-exporters and regular exporters in a single unified framework. The paper shows how the presence of domestic trade cost alongside of the sheer magnitude of processing trade drastically affects how the impact of trade is distributed across different types of firms. The least productive firms behave only as pure exporters; the most efficient ones reap benefits from trade in the form of gains in revenue and profit; and less efficient firms focus on the domestic market. On the other hand, the paper shows the existence of domestic and export costs does not affect the welfare-enhancing properties of trade: falling trade costs unequivocally deliver welfare gains in both countries.