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Trade Potential: A New Measure of Openness

Author

Listed:
  • Mike Waugh

    (New York University)

  • B Ravikumar

    (Federal Reserve Bank of St Louis)

Abstract

In this paper we derive a new measure of openness—the trade potential index—that quantifies the potential gains to trade as a simple function of data. Using a standard multicountry trade model, we measure openness by a country’s potential welfare gain from moving to a world with frictionless trade. A country’s trade potential depends on only the trade elasticity and two observable statistics: the country’s home trade share and its income level. Quantitatively, poor countries have larger trade potentials relative to rich countries, while their welfare costs of autarky are similar. This leads us to infer that rich countries are more open to trade. Our trade potential index correlates strongly with estimates of trade costs, while both the welfare cost of autarky and the trade-to-GDP ratio exhibit weak correlations with trade costs. Thus, our measure of openness is informative about the underlying frictions to trade.

Suggested Citation

  • Mike Waugh & B Ravikumar, 2016. "Trade Potential: A New Measure of Openness," 2016 Meeting Papers 1329, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1329
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    References listed on IDEAS

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    1. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    2. Finicelli, Andrea & Pagano, Patrizio & Sbracia, Massimo, 2013. "Ricardian selection," Journal of International Economics, Elsevier, vol. 89(1), pages 96-109.
    3. Michael Sposi & B Ravikumar & Piyusha Mutreja, 2014. "Capital goods trade and economic development," 2014 Meeting Papers 1374, Society for Economic Dynamics.
    4. Robert C. Feenstra & Alan Heston & Marcel P. Timmer & Haiyan Deng, 2009. "Estimating Real Production and Expenditures across Nations: A Proposal for Improving the Penn World Tables," The Review of Economics and Statistics, MIT Press, vol. 91(1), pages 201-212, February.
    5. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-116, March.
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