Trading Away Wide Brands for Cheap Brands

Firms face competing needs to expand product variety and reduce production costs. Trade policy affects firm investments in product variety and production processes differently. Access to larger markets enables innovation to reduce costs. Although firm scale increases, foreign competition reduces markups. Firms react by narrowing their product varieties to recapture these lost markups. I provide a theory detailing this conflicting impact of trade policy and address welfare gains from trade. Accounting for firm heterogeneity, I show support for the theoretical predictions with firm-level innovation data from Thailand's manufacturing sector which experienced unilateral home tariff changes during 2003-2006.