entrepreneurship to become informal.<sup>42</sup> Similarly, tax policy should anticipate distortions to firm growth that happen when firms of different sizes face differential enforcement.<sup>43</sup> These are examples that illustrate the breadth of the importance of understanding the aggregate impact of policies at a more disaggregated level.

# **Micro evidence on the aggregate welfare effects of trade**

Micro‐level evidence yields important new insights on aggregate outcomes in the field of international trade as well. Influential recent research shows <mark>that the aggregate welfare gains from trade may not be as big as previously thought, particularly for large countries with a smaller share of trade in GDP.</mark><sup>44</sup> <mark>However, subsequent research based on micro data on products, firms, and industries shows that there are subtle but important nuances in the calculations of aggregate welfare gains from trade that could depend on sectoral linkages and the structure of the tariffs. If the products of one sector are used as inputs in other sectors, then the aggregate w</mark> elfare gains from trade could be higher as expansion in one sector indirectly benefits the other sectors through these linkages.<sup>45</sup> On the other hand, for those countries where higher tariffs are imposed on imported products that respond less to tariff changes, the aggregate welfare gains from trade could be less.<sup>46</sup> This could be because firms are locked into fixed import patterns in global value chains and may not switch inputs in response to tariff changes in the short run. All these nuances are missing when we only focus on aggregate statistics such as average tariff rates.

<mark>The bottom‐up approach yields insights on how trade affects workers, firms, and localities differently. For example, low‐cost imports from China increase unemployment, lower labor force participation, and reduce wages in some local labor markets in the United States, contributing to one‐quarter of the contemporaneous aggregate decline in U.S. manufacturing employment, e</mark> ven though the aggregate welfare gains from trade with China are positive.<sup>47</sup> <mark>The firm‐level approach also reveals that there are significant downward biases in aggregate measures of domestic value added embodied in exports. This is because aggregate statistics are mainly constructed based on data from large firms, which tend to use more imported material inputs and therefore produce less domestic value added. The new firm‐level approach aggregates firms’ domestic value added</mark> from the ground up based on customs transaction data for all firms, not just large ones <mark>. Based on this firm‐level</mark>

> 42 Bruhn, M., McKenzie, D., 2014, “Entry Regulation and Formalization of Microenterprises in Developing Countries”, World Bank Research Observer, 29(2): 186‐201, 2014.

> 43 Bachas, P., Fattal‐Jaef, R. N., Jensen, A., 2019, “Size‐Dependent Tax Enforcement and Compliance: Global Evidence and Aggregate Implications. **”** _Journal of Development Economics, 140._

> 44 Arkolaskis, C., Arnaud C., Rodriguez‐Clare, A., 2012, “New Trade Models, Same Old Gains?” American Economic Review 102(1): 94‐130.

> 45 Caliendo, L., and Parro, F. 2015.  ”Estimates of the Trade and Welfare Effects of NAFTA.”  The Review of Economic Studies 82 (1), 1–44.

> 46 Kee, H.L., and Nicita, A. 2017.  "Gains from Trade and Heterogeneous Trade Elasticities: Assessing the Short Term Impact of Brexit on the United Kingdom's Export of Goods," World Bank Policy Research Working Paper8195.

> 47 Autor, D., Dorn, D., and Hanson, G. 2014, “The China Syndrome: Local Labor Market Effects of Import Competition in the United States.” American Economic Review.

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