Reverse Selection and Crowding-In in Trade with Heterogeneous Firms

When countries are asymmetric, trade with heterogeneous firms can crowd in less productive firms, and can reverse select less productive firms to specialize in export. Whether and how these outcomes will arise depends on a country’s standing in the world. In particular, reverse selection takes place in a country that is more populous or less productive than its trading partners, while crowd-in can occur in a sufficiently populous country but not in trading countries that differ only in productivity. Our study helps reconcile empirical findings that are contradictory to the existing theoretical literature, and highlights the importance of country heterogeneity in understanding trade with firm heterogeneity.