Trade costs, home bias and the unequal gains from trade

Abstract

International trade affects consumption prices, with potentially different impacts on poor and rich consumers. We study these unequal impacts building on the Almost Ideal Demand System (AIDS) gravity model of Fajgelbaum and Khandelwal (2016). We augment the original model with a home bias in tastes and allow for trade costs to differ for domestic and foreign trade. In this setup, we show that the structural parameters governing the welfare gains are highly sensitive to the determinants of spending on domestic goods. This extension largely weakens the pro-poor bias of trade which leads us to conclude that the AIDS gravity framework does not generate robust results about the distributive effects of trade within countries.