Trade direction, market access and regional wage inequality: An explanation based on asymmetric trade costs

Abstract

AbstractWe introduce the trade frictions between wealthy and impoverished regions into the New Economic Geography model. We argue that to reconcile bilateral trade volumes and price data within a standard gravity model, the trade frictions between regions must be systematically asymmetric, with poor regions facing higher costs to export relative to affluent regions. We construct the corresponding econometric model based on the theoretical formulation, and the results show that the asymmetry of trade costs has a significant impact on regional market access and wages. We then argue that these trade frictions are quantitatively crucial and without the asymmetry of trade costs, the standard deviation of market access among Chinese provinces would decline by 13.9%, while that of relative wages would decline by 16.1%.