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Bilateral Trade, Relative Prices, and Trade Costs

  • The University of Iowa
  • Michael Waugh

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.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 781.

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Date of creation: 2008
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Handle: RePEc:red:sed008:781
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  1. Dornbusch, Rudiger & Fischer, Stanley & Samuelson, Paul A, 1977. "Comparative Advantage, Trade, and Payments in a Ricardian Model with a Continuum of Goods," American Economic Review, American Economic Association, vol. 67(5), pages 823-39, December.
  2. Kravis, Irving B & Lipsey, Robert E, 1988. "National Price Levels and the Prices of Tradables and Nontradables," American Economic Review, American Economic Association, vol. 78(2), pages 474-78, May.
  3. Hiau LooiKee & Alessandro Nicita & Marcelo Olarreaga, 2009. "Estimating Trade Restrictiveness Indices," Economic Journal, Royal Economic Society, vol. 119(534), pages 172-199, 01.
  4. Michael E. Waugh, 2010. "International Trade and Income Differences," American Economic Review, American Economic Association, vol. 100(5), pages 2093-2124, December.
  5. Hummels, David & Lugovskyy, Volodymyr & Skiba, Alexandre, 2009. "The trade reducing effects of market power in international shipping," Journal of Development Economics, Elsevier, vol. 89(1), pages 84-97, May.
  6. Douglas Gollin, 2001. "Getting Income Shares Right," Department of Economics Working Papers 2001-11, Department of Economics, Williams College.
  7. Jonathan Eaton & Samuel Kortum, 2001. "Trade in Capital Goods," NBER Working Papers 8070, National Bureau of Economic Research, Inc.
  8. Robert C. Feenstra & Robert E. Lipsey & Harry P. Bowen, 1997. "World Trade Flows, 1970-1992, with Production and Tariff Data," NBER Working Papers 5910, National Bureau of Economic Research, Inc.
  9. 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.
  10. 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.
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