Monday, January 2, 2017

Domestic vs. International Welfare Gains from Trade

Domestic vs. International Welfare Gains from Trade


One sentence summary: Domestic trade contributes about 91 percent to overall welfare gains from trade.

Abstract
Using varieties of a rich model that considers sectoral heterogeneity and input-output linkages, this paper shows that the overall welfare gains of a region within a country can be decomposed into domestic versus international welfare gains from trade. Empirical results based on state-level data from the U.S. suggest that about 91 percent of the overall welfare gains of a state are due to domestic trade with other states, on average across alternative model specifications, with a range between 72 percent and 99 percent across states. When national-level data are used for the U.S., international welfare gains are shown to be almost identical to the those obtained by the aggregation of state-level results, suggesting that one can use the implications of a region-level analysis to have national-level results based on welfare gains from trade. We use this implication to propose an approximation to measure the domestic welfare gains from trade when domestic trade data are not available. Accordingly, using the implications of the model introduced, a Dispersion of Economic Activity Index (DEAI) is introduced that depends on internal distance and elasticity measures. It is empirically shown that DEAI can capture domestic welfare gains from trade within the U.S. when standard internal distance and elasticity measures in the literature are employed. Important policy suggestions follow.


Non-technical Summary
Domestic trade of a typical state in the U.S. is about five times its international trade, where about three quarters of this domestic trade is achieved with other states. It is implied that a typical state is about 20 percent open to international trade, while it is about 60 percent open to domestic trade. Since welfare gains from trade are known to be directly connected to such openness measures for a vast variety of models, the greater part of the welfare gains are implied to be through domestic trade. Nevertheless, since domestic trade data are not available for the majority of the countries, the existing literature has mostly focused on international welfare gains from trade that represent only a small portion of overall welfare gains.

Within this picture, this paper introduces a rich model considering sectoral heterogeneity as well as input-output linkages, where the unit of investigation is set as regions representing U.S. states. As standard in the literature, the corresponding welfare gains from trade are shown to be a function of expenditure shares and model parameters, where changes in expenditure shares are used to capture the changes in welfare in case of a hypothetical change in trade costs. The corresponding literature has focused on the hypothetical case of an autarky in the context of international trade. This paper follows this literature by having the same definition of international autarky while calculating the international welfare gains from trade.

The main contribution of this paper is achieved by considering an additional/alternative hypothetical case of autarky, namely domestic autarky, which is useful to calculate the domestic welfare gains from trade. In particular, domestic autarky is defined as the case in which a region still imports products internationally, but the domestic trade with other regions of the same country is shut down in this hypothetical case. It is shown that the overall percentage welfare gains from trade is the summation of domestic and international welfare gains from trade.


Based on the significant difference between international and domestic openness measures of states in the U.S., the corresponding welfare analysis shows that about 91 percent of the overall percentage welfare gains of a state are due to domestic trade with other states, on average across alternative model specifications, with a range between 72 percent and 99 percent across states.


When the same investigation is replicated at the U.S. level, it is shown that the international welfare gains from trade measures are almost identical to the measures obtained by the state-level analysis. Therefore, one can use the implications of a state-level analysis to have U.S. level results based on welfare gains from trade. We combine this result with other implications of the model in order to propose an approximation for domestic welfare gains from trade when domestic trade data are not available. Accordingly, we introduce a Dispersion of Economic Activity Index (DEAI) that can be calculated by using domestic distance measures (that can easily be obtained within a country) as well as other parameters such as trade elasticity and distance elasticity of trade costs. It is empirically shown that the proposed DEAI can capture the effects of domestic welfare gains from trade within the U.S. when great circle distance measures (that are calculated using latitudes and longitudes of states) are employed together with the elasticity measures borrowed from the literature.

Overall, this paper contributes to the existing literature by showing that (i) domestic welfare gains are much higher than international welfare gains from trade and (ii) when domestic trade data are not available, domestic welfare gains from trade can be approximated by a dispersion of economic activity index (DEAI). Regarding policy implications, the calculated DEAI measures can be compared with the standard measures of international welfare gains from trade in order to evaluate policies toward integrating the regions of a country with the rest of the world.




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