The effect of free trade agreements revisited: Does residual trade cost bias matter?

This paper revisits a prominent gravity model‐based empirical literature on the effects of free trade agreements by accounting for a potential bias caused by unobservable trade costs that operate through general equilibrium constraints. It embeds state‐of‐the‐art panel estimation techniques in a recently proposed two‐step remedy that features a constrained ANOVA‐type estimation. Using a dataset on manufacturing trade flows in eight sectors in 40 countries and a rest‐of‐the‐world aggregate for the period 1990–2002, it finds evidence of significant residual trade cost bias. The direction and magnitude of bias vary across sectors, with the standard one‐step approach used in the literature overestimating or underestimating the partial effect of free trade agreements by up to 110 percent. Overall, coefficients on trade costs variables are jointly significantly different between the standard method and the two‐step method. The biases in partial effect estimates translate into biases in general equilibrium effects.     

Shifting Armington trade preferences: A re-examination of the Mercosur–EU negotiations

This paper examines the ‘small share’ problem inherent within the constant elasticity of substitution Armington specification. As a de facto research tool in the quantitative trade literature, this structural bias plagues the results of numerous multi-region CGE studies. Kuiper and van Tongeren (2006) proposed a fusion of gravity and CGE specifications to remedy said bias, which the current paper further develops. With a pervasiveness of ‘small-share’ examples on Mercosur–European Union trade owing to the latter's restrictive tariff regime, the results reveal that significant additional trade led gains to Mercosur under a potential preferential trade agreement when compared with the standard Armington treatment.     

Home Bias,Border Effect and Internal Market Integration in China: Evidence from Inter‐provincial Value‐added Tax Statistics

This paper examines the home bias in regional trade and the integration of the internal market in China using inter‐provincial value‐added tax statistics. The administrative border between regions is an important trade barrier that results in home bias. Using a border effect model, we find evidence of home bias in provincial trade and relatively low border effects in domestic‐products trade in China. Moreover, the multilateral resistance model, based on a microeconomic foundation, also has strong power in explaining border effects in provincial trade. The empirical results imply that in accordance with some developed economies, China's market integration appears to have reached a high level.     

Armington elasticities in intermediate inputs trade: a problem in using multilateral trade data

Abstract.  In this paper we find that the estimates of Armington elasticities (the elasticity of substitution between groups of products identified by country of origin) obtained from multilateral trade data can differ from those obtained from bilateral trade data. In particular, the former tends to be higher than the latter when trade consists largely of intermediate inputs. Given that the variety of intermediate inputs traded across borders is increasing rapidly and that the effect of this increase is not adequately captured in multilateral trade data, the evidence shows that the employment of multilateral trade data to estimate Armington elasticities needs caution. JEL classification: F14, C51     

Do state borders matter for U.S. intranational trade? The role of history and internal migration

Abstract.  Empirical evidence of the impact of borders on international trade flows using the gravity equation approach abounds. This paper examines the empirical relevance of state borders in U.S. interstate trade for various specifications of the gravity equation. We find a large and economically significant subnational border effect for some specifications. However, two model specifications drastically reduce (if not eliminate) the border effect: (i) dynamic panel specifications controlling for past levels of trade and (ii) models conditioning on internal migration.     

Trade in the Triad: how easy is the access to large markets?

Abstract. In this paper, we measure market access between the United States, the EU, and Japan (the Triad), using the effect of national borders on trade patterns. We investigate overall and industry‐level trends of bilateral trade openness and provide explanations for those using proxies for bilateral observed protection (tariffs and NTBs), home bias of consumers, product differentiation, and levels of FDI. The explanations related to actual protection, home bias and substitutability of goods put together explain a large part of the border effect between blocs of the Triad, although they do not explain the whole of the border effect puzzle. JEL classification: F12, F15     

Learning How To Export

In this paper, we present a standard quality ladders endogenous growth model with one significant new assumption: it takes time for firms to learn how to export. It is known that the welfare gains from trade liberalization implied by a large class of models like the Armington gravity model, the Krugman model, and the Melitz model are small. Our quality ladders model is consistent with a number of firm‐level stylized facts from the heterogeneous firms trade literature and is, in addition, capable of generating very large welfare gains from trade liberalization.     

Home country bias in international emissions trading: Evidence from the EU ETS

We examine the pattern of allowance trades in the European Union Emissions Trading System (EU ETS) using highly disaggregated trading data and identify a significant and robust home market bias. Our results point to informational transactions costs that increase when trading across national borders. The existing trade pattern in goods and services explains two thirds of the home bias, with the remainder due to other causes. Our finding suggests that firms make use of existing trade networks to overcome search costs in bilateral allowance trade. Since the home bias differs across firms, it follows that marginal abatement costs are not equalized across market participants of the EU ETS.     

Borders and distance in knowledge spillovers: Dying over time or dying with age?—Evidence from patent citations

This paper explores the effects of distance as well as subnational and national borders on international and intranational knowledge spillovers through patent citations across the 39 most patent-cited countries and 319 metropolitan statistical areas (MSAs) within the U.S. In contrast to previous findings that knowledge localization fades over time, border and distance effects increase over time for the same-age citations. This increasing effect of borders and distance is associated with strengthened knowledge agglomeration over time. Nevertheless, both border and distance effects decrease with the age of patents. Aggregate border effects are often overestimated due to various aggregation bias. Moreover, business travels and knowledge quality effectively attenuate the effect of subnational borders in knowledge flows.     

National Borders, Trade and Migration

The paper confirms a strikingly large effect of national borders on trade patterns. Estimates comparing trade among Canadian provinces with that between Canadian provinces and US states show interprovincial trade in 1988–90 to have been more than 20 times as dense as that between provinces and states, with some evidence of a downward trend since, owing to the post-FTA growth in trade between Canada and the USA. Using approximate data for the volumes and distances of internal trade in OECD countries, the 1988–92 border effect for unrelated OECD countries is estimated to exceed 12. Estimates from a census-based gravity model of interprovincial and international migration show a much higher border effect for migration than for trade, with interprovincial migration among the Anglophone provinces almost 100 times as dense as that from US states to Canadian provinces.     

The trade impact of European Union agricultural preferences

We assess the impact on agricultural trade of European Union (EU) trade policies, using a gravity model based on disaggregated trade flows from 161 developing countries (DCs) to 15 EU member countries. We use a sample selection framework to account for potential selection bias of positive trade flows and provide an explicit measure for relative preference margins. From a policy perspective, our results debunk some of the most widespread criticisms of preferential policies: EU preferences matter and have a positive impact on DCs agricultural exports at both the extensive and intensive margins, although with significant differences across sectors.     

Economic integration agreements,border effects,and distance elasticities in the gravity equation

Using a novel common econometric specification, we examine the measurement of three important effects in international trade that historically have been addressed largely separately: the (partial) effects on trade of economic integration agreements, international borders, and bilateral distance. First, recent studies focusing on precise and unbiased estimates of effects of economic integration agreements (EIAs) on members׳ trade may be biased upward owing to inadequate control for time-varying exogenous unobservable country-pair-specific changes in bilateral export costs (possibly decreasing the costs of international relative to intranational trade); we find evidence of this bias using a properly specified gravity equation. Second, our novel methodology yields statistically significant estimates of the declining effect of “international borders” on world trade, now accounting for endogenous EIA formations and unobserved country-pair heterogeneity in initial levels. Third, we confirm recent evidence providing a solution to the “distance-elasticity puzzle,” but show that these estimates of the declining effect of distance on international trade are biased upward by not accounting for endogenous EIA formations and unobserved country-pair heterogeneity. We conclude our study with numerical general equilibrium comparative statics illustrating a substantive difference on trade effects of EIAs with and without allowance for the declining effects of international borders on world trade.     

The border effects in Spain: an industry-level analysis

A gravity-model approach is used to estimate the magnitude of the internal border (home bias) and external border (frontier) effects in Spain using industry-level trade flows. We find that the average border effects are about 30 and 10, respectively. Next we explore the variation in the industry-specific border effects. First, the border effects are larger in highly product differentiated industries. Second, the internal border effect is twice bigger for trade in intermediate goods than for trade in final goods. Third, conditioning on the geographic concentration of firms reduces significantly the internal border effect.     

Comparison of deep integration in the Melitz,Krugman and Armington models: The case of The Philippines in RCEP

We estimate the welfare effects of a modern mega-preferential trade agreement--the Regional Comprehensive Economic Partnership--with three versions of market structure: (i) perfect competition, Armington style; (ii) monopolistic competition based on Krugman (1980); and (iii) monopolistic competition in the style of Melitz (2003). We develop a new numerical model of foreign direct investment (FDI) with heterogeneous firms and extension of the Krugman model that allows small countries to impact the number of varieties. We hold both the trade and FDI responses constant across the three market structures. We find that in all three market structures, there are substantial gains from deep integration, but virtually no gains from preferential tariff reduction. Both our Krugman and Melitz style models produce significantly larger welfare gains than the Armington structure, especially if third countries benefit at least partially from the deep integration reforms via either spillovers or wider liberalization.     

BORDER EFFECTS WITHOUT BORDERS: WHAT DIVIDES JAPAN'S INTERNAL TRADE?

This article identifies a “border” effect in the absence of a border. The finding that trade between east and west Japan is 23.1% to 51.3% lower than trade within both country parts is established despite the absence of an obvious east–west division due to historical borders, cultural differences, or past civil wars. Postwar agglomeration processes, reflected by the contemporaneous structure of Japan's business and social networks, instead of cultural differences, induced by long‐lasting historical shocks, are identified as an explanation for the east–west bias in intra‐Japanese trade.     

The Armington assumption and the size of optimal tariffs

There has been commentary on the seeming success of the world trading system in responding to the large shock of the 2008 financial crisis without an outbreak of retaliatory market closing. The threat of large retaliatory tariffs and fears of a 1930s style downturn in trade have been associated with numerical trade modelling, which projects post retaliation optimal tariffs in excesses of 100%. In the relevant numerical modelling, it is common to use the Armington assumption of product heterogeneity by country. Here, we argue and show by numerical calculation that the widespread use of this assumption gives a large upward bias to optimal tariffs, both first step and post retaliation, relative to alternative homogenous good models used in trade theory. The reason is that optimal tariffs equal the inverse of the foreign export supply elasticity and are negatively related to the elasticity of the foreign offer curve. The Armington assumption model has a much more bowed foreign offer curve, which generates unrealistic larger optimal tariffs.     

National borders and international trade: evidence from the European Union

In this paper the impact of national borders on international trade within the European Union is considered. Using a gravity model, I find that, averaged over all EU countries, intranational trade is about ten times as high as international trade with an EU partner country of similar size and distance. This relatively strong home bias suggests that even within the European Union national borders still have a decisive impact on trade patterns. JEL Classification: F02, F14, F15, O52
Ce mémoire examine l'impact des frontières nationales sur le commerce international à l'intérieur de l'Union européenne. On montre que, en moyenne pour tous les pays de l'Union européenne, le commerce intranational est à peu près dix fois plus important que le commerce international avec un pays partenaire de l'Union européenne de même taille et à même distance. Ce degré relativement important de préférence nationale suggère que, même dans le cadre de l'Union européenne, les frontières nationales ont encore un impact déterminant sur les patterns de commerce.     

Consistent Estimates of Regional Blocs' Trade Effects

This paper builds upon Feenstra (2002) to obtain consistent estimates of trade effects of regional blocs by adding bilateral effects to the gravity equation and analyzing its variation across blocs of different intensity. The results are then compared across different gravity equations used in the literature only to observe significant variation in sign, magnitude, and significance. The consequent equation shows that the effect is positive for economics cooperation agreements and preferential trade agreements, but free‐trade agreements do not have a significant incremental effect. While customs unions have a positive incremental effect over blocs of lower intensity, the incremental effect is mixed for monetary unions, and negative for economic areas and full integrations. Furthermore, the effect varies with the duration and degree of implementation as well as the coverage of blocs. Lastly, changes in trade effects of the European blocs across time observed and policy implications are discussed.     

National borders matter … where one draws the lines too

Abstract The fact that crossing a political border dramatically reduces trade flows has been widely documented in the literature. The increasing number of borders has surprisingly attracted much less attention. The number of independent countries has indeed risen from 72 in 1948 to 192 today. This paper estimates the effect of political disintegration since World War II on the measured growth in world trade. We first show that trade statistics should be considered carefully when assessing globalization over time, since the definition of trade partners varies over time. We document a sizeable resulting accounting artefact, which accounts for 17% of world trade in 2007. Second, based on a structural gravity equation, we estimate that since World War II political disintegration alone has raised measured international trade flows by 7% but decreased actual trade flows (including inter‐regional trade) by 2%.     

International asset prices and portfolio choices under Bayesian learning

We calculate equilibrium asset prices and portfolio choices from a two-country OLG international asset pricing model under the assumption that investors are on a Bayesian learning path. Investors from both countries receive identical information flows, but domestic investors start off with less precise priors concerning foreign fundamentals. Learning is shown to produce first-order effects on the properties of asset prices, in the form of increased equity returns, volatility clustering, and time-varying correlations across national stock markets. Moreover, on a learning path, estimation risk generates portfolio biases similar to those observed empirically, i.e. a strong preference towards domestic securities and excessive turnover in foreign securities. These findings are robust to changes in prior beliefs, the calibration of initial information asymmetries, and the parameterization of the model. We use real GDP data for the US and Europe to calibrate the model and show that in the event of a financial liberalization during the 1970s, high excess returns, time-varying volatility, substantial home bias, and excess turnover should have been observed.