Import Substitution Revival and the Welfare Gains of International Fragmentation

This study examines the welfare effects of a trade shock resulting from a complete shutdown of trade in intermediate inputs. Novel insights into the implications on consumption possibilities are derived within the framework of a model incorporating endogenous quality and substitution between intermediate inputs and final goods. The analysis shows that the loss of access to foreign intermediate inputs by a country’s local producers increases the price of final goods. However, this increase is partially offset by a rise in imports of final goods utilizing previously imported inputs. Empirical evidence establishes the existence and increasing prevalence of this phenomenon over time. JEL classification code : F100, F620