Geography, Income, and Trade in the 21st Century

39 Pages Posted: 19 Dec 2017 Last revised: 30 May 2021

See all articles by Dan Liu

Dan Liu

Shanghai University of Finance and Economics

Christopher M. Meissner

University of California, Davis

Date Written: December 2017

Abstract

We investigate the relationship between GDP per capita, trade costs, demand, and income inequality between 1996 and 2011. Specifically we apply the aggregate AIDS-based gravity model as developed in Fajgelbaum and Khandelwal (2016) to a panel of 40 countries to generate a new measure of market potential. We then relate this measure of market potential to country level GDP per capita finding a significant positive relationship which performs better than CES-based measures of market potential. The AIDS model allows for non-homotheticities in demand and the possibility that nations produce goods with higher or lower income elasticities so that income inequality and GDP per capita matter for the direction of trade. CES-based market potential measures are typically only a function of overall income and trade costs, but in AIDS relative incomes and average incomes matter. We also go beyond this partial equilibrium relationship and explore the welfare effects of a unilateral decline in international trade costs. A 10% decline in import prices induces an average rise in welfare of 2% for importing countries. This effect is larger for smaller countries and depends in an interesting way on the income elasticity of demand for source and destination products.

Suggested Citation

Liu, Dan and Meissner, Christopher M., Geography, Income, and Trade in the 21st Century (December 2017). NBER Working Paper No. w24121, Available at SSRN: https://ssrn.com/abstract=3089517

Dan Liu (Contact Author)

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Christopher M. Meissner

University of California, Davis ( email )

One Shields Avenue
Apt 153
Davis, CA 95616
United States

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