Variable Trade Costs Research Articles

Demand Uncertainty, Selection, and Trade

This paper examines the role of uncertainty on elasticities of trade flows with respect to variable trade costs in a canonical model of trade with monopolistic competition and heterogeneous firms. We identify two channels through which uncertainty impacts trade: through export participation thresholds (the selection effect) and the distribution of shocks governing export selection (the dispersion effect). While the selection effect dampens trade elasticities under uncertainty, the dispersion effect is ambiguous. We develop a methodology for using customs firm-level data to quantify trade elasticities under uncertainty, and the magnitude of each of the two channels through which uncertainty impacts trade. We find that uncertainty amplifies trade elasticities, on average, indicating that the dispersion effect of idiosyncratic firm-level shocks dominates -- though the effect is heterogeneous across industries. The overall magnitude of the endogenous selection mechanism on trade elasticities is small, indicating that the main drivers of trade in this class of trade models are overwhelmingly incumbent firms.

How do firms adjust when trade stops?

We investigate how firms adjust to the introduction of sudden, unanticipated, and eventually long-lasting economic sanctions. In 2014, Russia introduced sanctions on imports from Europe, which caused an abrupt negative shock to the food production sector in Lithuania. We find that part-time employment is used as the first shock absorber, followed by full-time employment. Investment reacts immediately but also additionally in the later periods if part-time employment adjustments that proxy for the firm's exposure to the permanence of the shock are large. At the same time, firms dampen shock effects by expanding to other export markets. To rationalize this firm behavior, we provide a theoretical mechanism where forward-looking firms face nonconvexities in the labor market along with heterogeneous variable trade costs.

Trade liberalization along the firm size distribution: The case of the EU‐South Korea FTA

AbstractLeading theories suggest that amongst continuing exporters, lower variable trade costs should boost exports of smaller firms by the same or greater percentage rate than larger firms. However, investigating the impact of the deep EU‐South Korea FTA with French customs data, we find robust evidence to the contrary. Applying a triple‐difference framework, we report that the FTA increased sales in the top quartile of continuous exporters by 71.5% points more than in the bottom quartile. More than 90% of that growth premium is driven by reductions in NTBs. These findings suggest an additional channel driving the distributional effects of FTAs.

Increasing marginal costs, firm heterogeneity, and the gains from “deep” international trade agreements

Two parameters are central to modern quantitative models of trade flows: the elasticity of substitution in consumption (σ) and the inverse index of heterogeneity of firms' productivities (θ). However, structural parameter estimation using the seminal Feenstra econometric methodology focuses on estimates of only σ and a bilateral export-supply elasticity (labeled γ). Separately, modern trade agreements are increasingly “deep,” meaning they reduce fixed trade costs alongside variable trade costs. First, in the spirit of Arkolakis (2010), we extend the Melitz model of trade to allow for increasing marginal market-penetration costs in an empirically tractable manner to help understand the relative impacts on trade, extensive margins, intensive margins, and welfare of reducing fixed trade costs and variable trade costs. Second, we provide a microeconomic foundation for estimating all three parameters using the Feenstra methodology alongside a gravity equation. Third, we demonstrate the importance of increasing marginal costs for shallow and deep trade-agreement liberalizations using two counterfactual exercises.

Interest Rates and World Trade: An “Austrian” Perspective

I develop a framework to study the interplay between world trade and interest rates. The model incorporates an explicit notion of time and production length, in the “Austrian” tradition of Bohm-Bawerk (1889). Changes in the interest rate affect production lengths, labor productivity, and the financial costs of exporting. I decompose the response of the volume of world trade to changes in the interest rate into four components: a labor productivity effect, a “propensity to consume out of labor income” effect, a “temporal dimension of variable trade costs” effect, and a “selection into exporting” effect.

Firms’ entry choices across export products and markets, and the consequences of trade in an open economy: Evidence from China

We outline a model of endogenous choices of market entry and product scope in a partial-equilibrium model of heterogeneous firms with arbitrary productivity. Firms’ choices of interest depend on market characteristics including variable trade and fixed market-entry costs. Conditional on fixed costs, the extent to which firms respond to shocks depends on their (potentially nonparametric) density around the zero-profit threshold. Accordingly, identical changes in, e.g., variable trade costs per product and market can lead to vastly different responses across not only markets and products but also firms. We shed light on the heterogeneity of these responses by estimating parameters and otherwise calibrating the model to firm-and-product-level bilateral trade data for China.

Latent Exports: Almost Ideal Gravity and Zeros

Abstract Export promotion at the extensive margin is a key concern of governments. We develop measures of how far firms in origin sectors are from break-even entry in destination markets. The measure is based on Almost Ideal gravity featuring heterogeneous price and income elasticities. Tobit estimation of 2006 trade flows for 75 countries and 25 sectors generates Latent Trade Bias (LTB) – the latent (projected) trade share of non-partners minus the as-if-frictionless trade share. Explained LTB variance decomposition shows that variable trade costs (distance and tariffs together) account for zero flows more than do fixed trade costs (entry cost) and income variation.

The Decomposition of Information and Communication Technology Products Trading: A Case Study of China

Technology is recognised as one of the most important factors in world economic development, particularly contributing to the trade growth of information and communications technology (ICT) products. The decomposition of export growth has been a popular way to analyse how trade has been influenced since 2000. However, there is little investigation regarding the structure of ICT product trading of China, which is the de facto largest trader of ICT goods export and import. This paper contributes to the existing methods with a non-parametric model. The coefficient estimates which functions of their factors represent a dynamic analysis of the factors’ influence on decomposed trade growth. The empirical study shows that China’s strategy tends to be conservative, as the growth of trade to developed countries mostly came from the volume increase of existing trade lines instead of the increase of trade varieties. Suggestions include that the trade growth could benefit from resource reallocation in ICT industries and the procedure simplification of exporting ICT products. This paper also provides empirical evidence that the Belt and Road Initiative (BRI) increased the trading volume and frequency by completing the transportation chain and decreasing the variable trade costs. Furthermore, suggestions are provided on improving the impact on the globalisation of ICT.

How costly is exporting? An empirical assessment of trade model with heterogeneous firms

Foreign market access cost, explored by Melitz (2003) in the heterogeneous firm model of international trade, is one of the essential assumptions that ensure a nice fit of model results to stylized facts. Selection of more productive firms into exporters is guaranteed by the ex‐ cess of export fixed costs, adjusted for variable trade costs, over fixed costs of production. While there is empirical evidence on export cost structure at the level of firms, there has been no evaluation of the overall size of these costs. This paper aims at filling the gap. First, the model of Melitz (2003) is extended to allow asymmetries between trading countries. Then, the parametric relation between aggregated economic parameters is derived, which allows estimating the ratio of fixed costs. Then the relation is estimated empirically for the universe of Russian firms from 2014 to 2019, and results indicate that the foreign market access costs are comparable to the fixed cost of production in this setting. These findings provide evidence of the empirical relevance of the partitioning condition.

Truncated productivity distributions and the intensive trade margin

We derive a novel analytical relationship to show that for an upper truncated Pareto distribution average firm exports fall with variable trade costs and rise with the truncation limit. We extend the analysis to consider truncated lognormal and Fréchet distributions.

How the Internet Promotes China's Exports: A Firm‐level Perspective

AbstractThe development of information and communications technology (ICT), particularly the Internet, has reduced trade costs. However, it remains unclear whether these reduced costs are reflected in the “extensive margins” of firms’ exports (which refer to the probability of firms exporting) or the “intensive margins” (which refer to the value of firms’ export). To test this, we used the concepts of information cost and binary margins, an augmented trade model of firm heterogeneity, a two‐stage Heckman estimation, and data from the World Bank Enterprise Survey of Chinese firms in 2012. The results revealed that reduced trade costs from the use of ICT were positively related to extensive margins but that the connection with intensive margins was not significant. The results lead to the conclusion that reduced information costs related to a firm's exporting behavior were primarily reflected in variable trade costs. This study offers theoretical and empirical evidence for China's policies towards the Internet, which are relevant for the export of manufactured goods. The government should encourage the use of ICT to enhance firms’ export opportunities while facing current trade policy uncertainty.

The Margins of Intermediate Goods Trade: Theory and Evidence

This paper develops a heterogeneous-firm model in which firms in asymmetric countries in terms of sizes and trade costs export and import intermediate goods subject to selection. We show that the elasticity with respect to variable trade costs is greater for intermediate goods than for final goods, mainly due to the extensive margin. Using China Customs data with tariff-gravity data, we empirically assess the impact of tariffs as well as distances on China’s imports and find empirical evidence in support of our prediction of the model.

The double EMG distribution and trade elasticities

AbstractUsing Brazilian export data that, unlike many trade data sets, have a full record of small export sales, this paper reconsiders trade elasticities and the welfare gains from trade. Using the Brazilian data, this paper provides novel evidence on the properties of the distributions of log‐export sales and shows that the double exponentially modified Gaussian (EMG) distribution parsimoniously captures these properties. Using the double EMG distribution in a standard monopolistic competition model of trade, this paper demonstrates that data truncation, which is prevalent in many data sets, leads to an upward bias in measuring the partial elasticity of trade with respect to variable trade costs. This bias subsequently leads to the underestimation of the gains from trade by 1% to 9% depending on the extent of data truncation, a range that is commensurate with typical economic growth and large booms.

Imported inputs and the gains from trade

This paper characterizes how plant-level heterogeneity in imported input use affects the aggregate welfare gains from trade. Heterogeneous plants choose a fraction of inputs to source from the lowest cost source country, with the rest purchased domestically. Sourcing more inputs requires higher up-front fixed costs, but reduces variable input costs, so import shares are increasing in plant size. Welfare gains are inversely proportional to the general equilibrium elasticity of the aggregate import share with respect to variable trade costs. A standard bilateral gravity regression underestimates this elasticity by not capturing the effects of trade costs on the input sourcing decision. The welfare gains from trade in the model are therefore lower than the gains implied by a gravity-based estimate of the trade elasticity. When calibrated to Chilean plant-level data, this difference is substantial.

Powerless: gains from trade when firm productivity is not Pareto distributed

Most trade models featuring heterogeneous firms assume a Pareto productivity distribution, on the basis that it provides a reasonable representation of the data and because of its analytical tractability. However, recent work shows that the characteristics of the productivity distribution crucially affect the estimated gains from trade. This paper thoroughly compares the gains from trade obtained under three different productivity distributions (Pareto, lognormal, and Weibull) and investigates their policy implications. We find that both the magnitude of the welfare gains and the relative importance of the fixed versus variable trade costs change significantly. Hence, relying blindly on a single distribution is dangerous when performing trade policy analysis.

Trade, Firm Selection and Innovation: The Competition Channel

The availability of rich …rm-level data sets has recently led researchers to uncover new evidence on the eects of trade liberalization. First, trade openness forces the least produc- tive …rms to exit the market. Secondly, it induces surviving …rms to increase their innovation eorts and thirdly, it increases the degree of product market competition. In this paper we propose a model aimed at providing a coherent interpretation of these …ndings. We intro- ducing …rm heterogeneity into an innovation-driven growth model, where incumbent …rms operating in oligopolistic industries perform cost-reducing innovations. In this framework, trade liberalization leads to higher product market competition, lower markups and higher quantity produced. These changes in markups and quantities, in turn, promote innovation and productivity growth through a direct competition eect, based on the increase in the size of the market, and a selection eect, produced by the reallocation of resources towards more productive …rms. Calibrated to match US aggregate and …rm-level statistics, the model predicts that a 10 percent reduction in variable trade costs reduces markups by 1:15 percent, …rm surviving probabilities by 1 percent, and induces an increase in productivity growth of about 13 percent. More than 90 percent of the trade-induced growth increase can be attributed to the selection eect.

Explaining the size differences of exporter premia: theory and evidence

Two decades of research have established pronounced exporter productivity premia (EPP) and exporter size premia (ESP). Yet, we do not know why such exporter premia differ so widely in magnitude across countries or sectors? We take this question to the theory and to the data. We derive the sectoral EPP and ESP in a standard heterogeneous firms trade model and apply the insights from the model to guide our empirical investigation of detailed Danish firm-level data. We show that a significant share of the observed variation in EPP and ESP across sectors can be accounted for by sector differences in the underlying variation in productivity dispersion, variable trade costs, the ratio of fixed export costs to fixed costs of production, and the elasticity of demand.

Spillovers from Foreign Exporters

AbstractWe develop a general equilibrium model of international trade with heterogeneous firms that accounts for productivity spillovers transmitted by foreign exporters. Everything else equal, stronger spillovers increase welfare. We embed the model framework into a trade policy scenario where countries strategically set inter‐country variable trade costs for the trading partner. In the strategic Nash‐equilibrium policy, governments trade‐off welfare gains from protectionism and those that are due to spillovers from foreign exporters. The equilibrium degree of protectionism is decreasing in the strength of the spillover. Policy coordination induces welfare gains but these gains can be hump‐shaped in the spillover strength.

Variable Trade Costs, Composition Effects and the Intensive Margin of Trade

AbstractWe estimate the elasticity of extra EU French firm‐level exports with respect to applied tariffs – a variable trade cost. We implement a method controlling for unobserved firm characteristics driving selection in exports market, and controlling for the multilateral resistance terms. Results confirm a significant negative impact of tariffs on firm‐level exports, with one fifth of this impact falling on the induced adjustment in the exporters' product mix. When controlling for this adjustment and focusing on the core exported products, the elasticity of the product‐destination firm‐level exports with respect to applied tariffs is estimated at about −2.5.

Trade Openness and Cross‐country Income Differences

AbstractThis paper asks how variations in trade openness contribute to cross‐country income differences. We approach this question using counterfactual experiments within a quantified general equilibrium model of trade. We find that trade costs gain their relevance only by amplifying the effects of existing differences in endowments, population sizes and technologies. If, for example, market entry costs were the same in all countries, inequality would be about 13% lower. Variable trade costs are found to have a similar effect. In contrast, if countries differed only by their degree of trade openness, the resulting variance of per capita income would be negligible.