Diminishing Gains from Trade across Countries: Interaction between Trade Elasticity and Openness
One sentence summary: The gains from trade decrease with trade openness when country-specific trade elasticity estimates are used.
The corresponding academic paper by Hakan Yilmazkuday is available as a working paper here.
Abstract
For a large class of structural gravity models in the literature, the gains from trade of a country increase with trade openness based on a common trade elasticity across countries. This paper shows that when the trade elasticity is allowed to be country specific and it increases with trade openness, it is possible for the gains from trade to decrease with trade openness under certain conditions, which we call as the diminishing gains from trade. In order to test this possibility, country-specific trade elasticity measures are estimated by using quarterly time-series data for 40 countries, where the model-implied macroeconomic relationship between the home expenditure share and the real income per capita is employed. The average trade elasticity is estimated about 2.7, with a range between 0.3 and 11.9 across countries. The corresponding gains from trade range between 4% and 65% across countries, with an average of about 30%. In a secondary cross-country analysis, the trade elasticity estimates are shown to increase and the gains from trade are shown to decrease with trade openness measures. It is implied that there are diminishing gains from trade with respect to trade openness.
Non-technical Summary
For a large class of structural trade models, the gains from trade of a country can be measured by using the trade elasticity and the home expenditure share. When the trade elasticity is common across countries, these models imply that the gains from trade increase with trade openness (that is defined as one minus the home expenditure share). This paper theoretically shows that when trade elasticity measures are allowed to be country specific, the gains from trade can decrease with trade openness under certain conditions, which we call as the diminishing gains from trade with respect to trade openness.In search for the diminishing gains from trade, this paper estimates country-specific trade elasticity measures by using the model-implied macroeconomic relationship between the home expenditure share and the real income per capita. The estimations are achieved individually for 40 countries by using structural vector autoregression (SVAR) models with quarterly time-series data covering the period between 2005q1 and 2021q4.
The average (across countries) trade elasticity estimate is estimated about 2.7, corresponding to the gains from trade about 30%. In a secondary cross-country analysis, trade elasticity estimates are shown to be increasing with trade openness, whereas the gains from trade are shown to decrease with trade openness, suggesting diminishing gains from trade with respect to trade openness.
Compared to the literature, this paper has the following contributions. First, it is theoretically shown that the gains from trade can decrease with trade openness under certain conditions when country-specific trade elasticity measures are considered. This in contrast to the case of having a common trade elasticity across countries, where the gains from trade increase with trade openness. Second, the trade elasticity estimations are achieved by using the model-implied macroeconomic relationship that is used to measure the gains from trade. This is useful to identify the country-specific trade elasticity estimates through the time dimension that is mostly ignored in the literature. Third, country-specific trade elasticity estimates are shown to increase with trade openness, which brings up the possibility of the gains from trade decreasing with trade openness. Fourth, this possibility is empirically tested, and it is shown that the gains from trade in fact decrease with trade openness.