This paper incorporates firm-level distortions into a Melitz model and characterizes welfare under misallocation. We derive an analogue to the well-known ACR result in an economy with distortions. We highlight a channel through which trade can reduce welfare by exacerbating misallocation. A key...

This paper formalizes a classic idea that in second-best environments trade can induce welfare losses. In a framework that incorporates distortion wedges into a Melitz model, we analyze a channel in which trade can reduce allocative efficiency arising from the reallocation of resources. A key...