Distorted Trade Barriers: A Dissection of Trade Costs in a “Distorted Gravity” Model

It is common in the trade literature to use iceberg transport costs to represent both tariffs and shipping costs alike. However, in models with monopolistic competition these are not identical trade restrictions. This difference is driven by how the two costs affect the extensive margin. We illustrate these differences in a gravity model. We show theoretically that trade flows are more elastic with respect to tariffs than transport costs and find a linear relationship between the elasticities with respect to tariffs, iceberg transport costs, and fixed market costs. We empirically validate these results using data on US product‐level imports.     

The core periphery model with asymmetric inter-regional and intra-regional trade costs

We generalize the model of Krugman (J Polit Econ 99(3):483–499, 1991) to allow for asymmetric trade costs between regions and for (asymmetric) trade costs that are internal to the regions. We find that industrial activity, in a region, is enhanced by higher costs of importing and lower costs of exporting (more precisely, by a higher ratio between the two trade costs). This suggests that countries may impose tariffs on imported goods and seek to remove the import tariffs in other countries (unilateral protectionism) in order to foster industrial activity. Industrial activity is also promoted by lower domestic internal trade costs and higher foreign internal trade costs (more precisely, by a lower ratio between the two trade costs).     

The Vertical Multinational Enterprise and International Trade

This paper analyzes an endogenous vertical multinational enterprise by explicitly modeling a distortion in the intermediate goods sector. Firms invest abroad to lower the cost of multistage production. The implications for international trade and investment differ markedly from the conventional wisdom of multinationals. Particularly, intrafirm trade in intermediates implies vertical investment complements rather than substitutes for trade. The decision to become a multinational depends on the level on foreign factor prices, the nature of the competition with foreign suppliers, transport, tariffs, and subsidiary plant costs. Marginal change in tariff may result in unintended welfare jumps as firm configuration shifts.     

A Note on Production Efficiency in Oligopolistic Trade Models

In a two‐country segmented markets model with homogeneous product Cournot oligopoly we show that production efficiency improves in the free‐trade regime compared to autarky, if autarky price in each country is lower than both the post‐trade prices—which holds, for example, when preferences are identical. The result holds irrespective of the demand structure, number, and cost distribution of firms in the two countries. The improvement in production efficiency lowers average cost of production which, for some parameterizations, gives rise to higher aggregate profits for all countries in the free‐trade regime (compared to autarky). Though free trade (zero tariffs) improves production efficiency from autarky (prohibitive tariffs), freer trade is not always associated with greater production efficiency.     

Some Economics of Integrated and Segmented Markets

For the purposes of the discussion in this paper, whether markets are integrated or segmented is endogenous and is determined by the interaction of demand parameters, tariffs, transportation costs, and arbitrage. Given certain restrictions, it is shown, in equilibrium, that policymakers choose tariffs to segment markets. The effects of trade liberalization (reducing all tariffs to zero) in an endogenous market structure framework are determined and compared to the existing literature. The results differ substantially, highlighting the importance of explicit modeling of costly arbitrage in imperfectly competitive models.     

The United States is a Small Country in World Trade*

Despite being the largest country in world trade and thus presumably having high optimal tariffs, the United States has long had low and declining levels of protection. This paradox suggests that the United States is failing to exploit its monopsony power by levying optimal tariffs. Using data on world output and trade flows, we find that the United States is a small country in world trade in that its trade policies have negligible impacts on world prices. In the median manufacturing industry, US tariffs reduce world prices by only 0.12%. United States optimal tariffs are also typically small (3.6% in the median industry) and are lower than existing US tariffs in most industries. It is no puzzle that the United States has been a champion of free trade since the 1930s—the United States, like other small countries, benefits economically from tariff reductions.     

China's Regional Trade and Domestic Market Integrations

The global economic crisis in 2007 forced China to move from export‐led growth to promoting domestic demand. The move is significant, but the success of this new growth strategy depends critically on the level of domestic market integrations. In this paper, we use the methodology proposed by Anderson and Wincoop to examine China's domestic market integrations. We find evidence of border effects at both national and regional levels with significant regional differences, but they are smaller than some earlier studies suggest. Income growth, lower transportation costs, and higher intra‐industry trade all have positive effects on China's regional trade. Among the factors affecting regional trade, a better business environment has the largest positive impact on lifting China's domestic trade between regions, especially in intermediate goods, suggesting that improving business environment should be the priority of government at all levels in China.     

The Welfare Cost of Autarky: Evidence from the Jeffersonian Trade Embargo, 1807–09

The United States came close to complete autarky in 1808 as a result of a self‐imposed embargo on international shipping from December 1807 to March 1809. Monthly prices of exported and imported goods reveal the embargo's striking effect on commodity markets and allow a calculation of its welfare effects. A simple general‐equilibrium calculation suggests that the embargo cost about 5 percent of America's 1807 GNP, at a time when the trade share was about 13 percent (domestic exports and shipping earnings). The welfare cost was lower than the trade share because the embargo did not completely eliminate trade and because domestic producers successfully shifted production toward previously imported manufactured goods.     

Can R&D-inducing green tariffs replace international environmental regulations?

This paper investigates the link between trade and environment by exploring the effects of green tariffs on innovation, location of production and the environment. It shows that tariffs levied on polluting goods could result in less world pollution than global harmonization of environmental standards by inducing more pollution-abatement R&D effort and generating lower unit emissions from production. Specifically, green tariffs reduce pollution by (1) shifting production to the region where environmental standards are respected, (2) inducing the firm in the clean country to engage in more abatement R&D by granting it a higher market power/share in its home market, (3) instigating green R&D investment by deterring delocation. When these outweigh the R&D-creating effect of environmental harmonization in the dirty country, green tariffs bring about a cleaner environment.     

The law of one price revisited: How do goods market frictions generate large and volatile price deviations?

This paper analyzes the role of goods market frictions in accounting for the large and volatile deviations from the Law of One Price (LOP) in a framework of flexible prices. We draw a distinction between the goods market frictions that are required to consume tradable goods (e.g., distribution costs) and those that are necessary for international transactions (e.g., trade costs). We find that trade costs generate LOP deviations by introducing a no-arbitrage band, while distribution costs cause the price to deviate from the LOP by affecting the probability that trade will occur, given the band. We then conduct a Monte Carlo simulation to show that real exchange rate volatility is positively associated with trade costs, but negatively related to distribution costs. This effect depends on the interplay of trade costs and distribution costs, as they work in opposite directions when creating arbitrage opportunities.     

Moving beyond the iceberg model: The role of trade relations in endogenizing transportation costs in computable general equilibrium models

Modeling trade and transportation costs is an essential part of multiregional or spatial computable general equilibrium models where interregional trade plays an important rolein shaping economic activity. The majority of such models use the iceberg trade cost approach where part of the produced output (representing the material costs of transportation) is assumed to melt away during transportation. There are a few models which employ a more refined approach with an explicit transportation sector providing transportation services which are then used to ship goods between locations. In this paper we show that this approach, although much more convenient than the iceberg approach, still lacks full usability due to the fact that markets, hence prices are defined at the regional level and as a result, transportation costs can not be endogenous at the trade relation level. Moreover, under regional level market clearing the iceberg and the more detailed approach are equivalent. We propose to refine the definition of market equilibrium and move it to the trade relation level. Using this approach we can gain full advantage of the explicit transport sector in the model with respect to trade cost evolution. We show through simulations that refining the way trade costs are modelled indeed gains new insights, and that moving the market definition to the trade relational level leads to qualitative changes in the effect of labor supply shocks on main model variables. The paper also presents a method to estimate a SAM by reallocating data from standard industries to a transportation sector which is then consistent with the model setup. This SAM can be used to calibrate the refined model with a detailed transportation sector.     

Transportation Costs and US Manufacturing FDI

In empirical models of foreign direct investment (FDI), distance is most often used to proxy for transportation costs and other pure‐trade costs. Given that distance is time invariant but transportation costs are not, this approach is less than satisfactory when actual transportation costs rise and fall over time.The contribution of this work is to explicitly control for transportation costs and thereby better understand their impact on FDI. We explore the impact of shipping costs on total US FDI stocks abroad, manufacturing stocks and service stocks using measures of sea‐shipping and air‐shipping costs in a Hausman–Taylor model that controls for endogeneity and allows for time‐invariant variables such as distance. We find that transportation costs have a positive and statistically significant relationship with US total and manufacturing FDI, suggesting a substitute relationship between FDI and trade flows consistent with horizontal MNE activity. As one would expect, these costs are insignificant for service stocks.     

The Ramaswami Argument in a Multi-commodity Setting

This paper considers the optimum taxes and tariffs in a multi-commodity setting. Using the argument in Ramawami (1968), I show that when all goods and factors are tradable, the home country should buy out all the foreign factors. Conditions for the optimal terms of trade are also analyzed. In a single consumption good model, the foreign factors should be bought out at the foreign autarky prices. This result is only partially true in the more general setting. While factor mobility should be prohibited before the buy-out, non-prohibitive tariffs have to be imposed on trade in goods to attain the optimum terms of trade.     

Sector and importer determinants of prices for traded intermediates

While the literature on traded goods prices emphasizes final goods prices and related consumer theory to explain variation in goods prices with importer characteristics, trade in intermediates actually constitutes about two thirds of total trade. We propose a mechanism for explaining variations in the prices of intermediates as a function of importer characteristics, wherein production is vulnerable to failure and the probability of failure declines in the quality of intermediates. Higher wages mean a greater opportunity cost of failure, leading to a stronger demand for high-quality intermediates where firms face higher wages. We find empirical support for this mechanism in the case of intermediate goods using IV regressions. In addition, our findings indicate that while the cost of labour explains about one fifth of variation in imported intermediate prices, it is a non-significant determinant of imported final goods prices.     

Markups,quality, and transport costs

This paper provides new evidence on trade prices based on firm-level data from France. It shows that firms charge higher free-on-board (net of transportation costs, hereafter noted as fob) unit values on exports to more distant countries. This finding holds within firms and products, and across destinations. The price premium paid by distant consumers is due to firms charging higher fob prices, and to higher transportation costs. A simple decomposition of the elasticity of import prices to distance shows that, after a fall in transport costs, almost 80% of the decline in import prices enjoyed by consumers is due to firms charging lower fob prices. This suggests a new channel through which changes in transport costs may affect welfare.     

Engel's law, Petty's law, and agglomeration

This paper presents a model of structural change and agglomeration. A decline in transportation costs, by enhancing consumers’ purchasing power, leads to Engel's law of the demand shift from agricultural to non-agricultural goods. At the same time, the decline in transportation costs, by enlarging the extent of the market for non-agricultural goods, induces Petty's law of the labor reallocation from agriculture to non-agricultural activities. These structural transformations weaken dispersion forces given by farmers tied to the land, whereas they strengthen agglomeration forces generated by footloose non-agricultural workers. Thus, a substantial decline in transportation costs gives rise to agglomeration of non-agricultural activities.     

A NEW THEORY OF DEMAND AND SUPPLY AND EMERGENCE OF INTERNATIONAL TRADE FROM DOMESTIC TRADE

Abstract. In the paper a fixed learning cost is introduced into a framework with consumer-producers and transaction costs. The fixed learning cost yields a rate of return on the investment in individual specific learning and training which is increasing in its rate of utilization. Division of labor can avoid duplicated learning costs and generate economies of specialized learning. The tradeoff between economies of specialization and transaction costs can be used to explain concurrent increases in the extent of the market, aggregate demand, productivity, trade dependence, the degree of market integration, the degree of production concentration, diversity of economic structure, variety of different professions, each person's level of specialization, and the extent of endogenous comparative advantage and the emergence of international trade from domestic trade. This model explains demand and supply as two sides of the level of division of labor which is determined by a transaction cost coefficient. Hence, the demand law may not hold even for normal goods owing to complicated interdependencies between the level of specialization and demand and between the level of specialization and prices of traded goods. The extended version of this model with the CES function is used to endogenize variety of consumption in addition to the endogenization of individuals'level of specialization.     

Switching the lights off: The impact of energy tariff increases on households in the Kyrgyz Republic

This paper describes an analysis of the impact that higher energy tariffs would have on households in the Kyrgyz Republic using micro-data from the 2009 Kyrgyz Integrated Household Survey. This analysis was conducted to determine which households would be most affected by higher energy tariffs and to what extent mitigation measures, such as lifeline tariffs or direct cash transfers, might lessen the impact for poor and vulnerable households. The analysis focused on first-order effects and used benefit incidence analysis and static micro-simulation to estimate the expected costs and benefits of higher energy prices and the corresponding mitigation measures. The results suggest that both the type of energy and the level of connectedness matter. Increasing tariffs for thermal power used for central heating and hot water mainly affects richer households in urban areas. Reducing implicit electricity subsidies affects the entire population due to nearly complete country coverage with electricity connections. Both lifeline tariffs and direct cash transfers could mitigate the effect of higher electricity tariffs at lower costs than universal subsidies.     

Fortress Europe: Jericho or Château d’If?

Traditional analysis of customs union formation suggests that it leads to an increase in members' external tariffs. This paper stresses two aspects of European trade and trade policy—a large volume of intra-industry trade between similar countries and a political motivation for tariffs—and highlights a role for tariff coordination in a model of differentiated products in which tariffs affect domestic costs and thus export prices and the magnitude of monopolistic rents. We show that when workers choose the tariffs and receive but a small portion of tariff revenues, the union's tariff wall falls.     

Whom to send to Doha? The shortsighted ones!

Analyses of the effects of trade policies focus on comparisons of two different steady states, restricting the investigation to the long run. In order to account for the adjustments and to capture the relevant transmission mechanisms of changes in trade costs, such as market size, entry and exit, as well as productivity changes of firms, we base our trade policy analysis on a dynamic new trade theory model. This approach has two advantages. (i) It allows us to take account of the transitional process after a change in tariffs. (ii) It allows us to take account of the shortsightedness of policy makers. We show that Nash-equilibrium tariffs based on a dynamic trade model are lower than Nash-equilibrium tariffs based on a static model. We also show that shortsighted politicians tend to set lower tariffs than politicians with a longer planning horizon.