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Bilateral Trade, Relative Prices, and Trade Costs

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  • The University of Iowa
  • Michael Waugh

Abstract

Poor countries import a larger volume of goods from rich countries, than rich countries import from poor countries. Furthermore, there is little difference in comparable price indices for tradable goods between rich and poor countries. Standard empirical implementation of structural gravity models with distance and other symmetric relationships for trade costs cannot account for both of these facts. To account for these facts, I argue that trade costs must be systematically asymmetric with poor countries facing higher costs to export relative to rich countries. I then demonstrate that asymmetry is quantitatively important accounting for at least a third of the variation in bilateral trade --- on par or more important than distance and other symmetric relationships. Given these observations, I propose a trade cost function and demonstrate how it can reconcile the discrepancy between the results of Eaton and Kortum (2001) and Hsieh and Klenow's (2007) observations regarding cross-country differences in the price of investment goods.

Suggested Citation

  • The University of Iowa & Michael Waugh, 2008. "Bilateral Trade, Relative Prices, and Trade Costs," 2008 Meeting Papers 781, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:781
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    References listed on IDEAS

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    1. Edward Balistreri & Russell Hillberry, 2006. "Trade frictions and welfare in the gravity model: how much of the iceberg melts?," Canadian Journal of Economics, Canadian Economics Association, vol. 39(1), pages 247-265, February.
    2. Balistreri, Edward J. & Hillberry, Russell H., 2007. "Structural estimation and the border puzzle," Journal of International Economics, Elsevier, vol. 72(2), pages 451-463, July.
    3. Baier, Scott L. & Bergstrand, Jeffrey H., 2001. "The growth of world trade: tariffs, transport costs, and income similarity," Journal of International Economics, Elsevier, vol. 53(1), pages 1-27, February.
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