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Can multi-stage production explain the home bias in trade?

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  • Kei-Mu Yi

Abstract

A large empirical literature finds that there is too little international trade, and too much intra-national trade to be rationalized by observed international trade costs such as tariffs and transport costs. The literature uses frameworks in which goods are assumed to be produced in just one stage. This paper investigates whether the multi-stage nature of production helps explain the home bias in trade. The author shows that multi-stage production magnifies the effects of trade costs. He then calibrates a multi-stage production model to the U.S. and Canada. He solves the model with measures of trade costs constructed from data on tariffs, transport costs, and wholesale distribution margins. The model can explain about 3/8 of the Canada border effect; this is three times more than what a calibrated one-stage model can explain. The model also explains a good deal of Canada’s vertical specialization trade. Finally, a reverse engineering exercise suggests that the unknown or unobserved component of trade costs is smaller than observed trade costs.

Suggested Citation

  • Kei-Mu Yi, 2008. "Can multi-stage production explain the home bias in trade?," Working Papers 08-12, Federal Reserve Bank of Philadelphia, revised 01 Nov 2008.
  • Handle: RePEc:fip:fedpwp:08-12
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    References listed on IDEAS

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    More about this item

    Keywords

    Production (Economic theory) ; Trade;

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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