This paper studies the influential Melitz model of trade with heterogeneous firms using an alternative, intuitive approach. Contrary to what is often argued, it is an increase in product market competition that drives the bad firms out: with two-way trade, entry by foreign firms is not compensated by a “sufficient” reduction in the mass of surviving firms. To illustrate this, we decompose the t...

1 Introduction The current process of east-west European integration is a particularly striking example of the re-emergence of strong trade and, more generally, production linkages between two groups of economies which, albeit geographically close to each other, have had minimal trade and FDI links over a forty-year period. The rapid and deep liberalization of external relations after 1989 (acc...