The Autonomy of Trade Elasticities: Choice and Consequences

Abstract

Fifty years of econometric work on trade assumes that trade elasticities are invariant to changes in spending patterns, that prices can be taken as given, and that expenditures on domestic and foreign goods can be studied independently of each other. To relax these assumptions, this paper assembles a simultaneous model explaining trade among Canada, Japan, and the United States. Spending behaves according to the Rotterdam model which, by design, embodies all of the properties of utility maxi­mization and does not treat trade elasticities as autonomous parameters. Pricing behaves according to the pricing-to-market hypothesis which recognizes exporters' incentives to discriminate across export markets. Parameter estimation relies on the Full Information Maximum Likelihood approach and uses bilateral price data for 1965-1987. According to the evidence, treating trade elasticities as autonomous parameters and ignoring the statistical implications of simultaneity and optimization un­dermines our effectiveness in addressing questions relevant to economic interactions among nations. Specifically, the estimates from the Rotterdam model predict that asymmetries in income elasticities, which were important once, have vanished.