Per capita income, market access costs, and trade volumes

There is strong empirical evidence that countries with lower per capita income tend to have smaller trade volumes even after controlling for aggregate income. Furthermore, poorer countries do not just trade less, but have a lower number of trading partners. In this paper, I construct and estimate a general equilibrium model of trade that captures both these features of the trade data. The key element of the model is an association between trade costs (both variable and fixed) and countries’ development levels, which can account for the effect of per capita income on trade volumes and explain many zeros in bilateral trade flows. I find that market access costs play an important role in fitting the model to the data. In a counterfactual analysis, I find that removing the asymmetries in trade costs raises welfare in all countries with an average percentage change equal to 29\% and larger gains for smaller and poorer countries. Real income inequality falls by 43\%.