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How Important Is Trade? Estimates from a World Trade Model

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Free Trade Agreements and Globalisation

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Abstract

This chapter presents a new world trade model that is simulated numerically with data from 2014. The model replicates country income levels realistically and sheds light on the difference between rich and poor countries in trade. It includes commodities and sheds light on terms-of-trade effects and the trade policy interests of commodity exporters. Quantifying the gains from trade, countries lose on average 27% of their income if trade is eliminated. Small countries and resource-abundant countries gain more. Human and physical capital endowments are even more important than trade and the most important driver of cross-country income differences. Applied to Brexit, it means that factor market implications may be important along with trade effects. On third place in the ranking of real income determinants, we find natural resource endowments. Such resources generate higher real income in several countries, but the resulting higher wages and prices reduce competitiveness and the number of firms in the manufacturing sector.

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Notes

  1. 1.

    Since K and L are fully utilised in the production of S, there is no K/L factor substitution across sectors. Alternatively, we might drop K and use a production function of the type aL, where a is a productivity parameter. We keep K and L for better correspondence with data; in particular, the correspondence between K/L and GDP per capita found in the growth literature (see Appendix B). The model can also be extended to allow K/L factor substitution.

  2. 2.

    The bilateral trade flows in G are not determined; for example, a commodity importer could buy a little from every commodity exporter or all from one. This is however not a problem or limitation.

  3. 3.

    This correlation is for the trade of the individual countries among the 110 countries and regions, since we do not have bilateral trade data for the subnational regions.

  4. 4.

    Some model components may be developed further in future research. For example, geography is represented here as a scaling of distance but a future aim is to include better data on transport modes and trade costs, bringing it closer to the new quantitative trade theory in later applications.

  5. 5.

    For brevity, more detailed results are not reported but these are available upon request.

  6. 6.

    The correlation between the change in welfare per capita and country size measured by L (the labour stock) is 0.55; and with natural resource abundance measured by G/L the correlation is −0.49. Fishery resources are not included in the World Bank natural resource data and so Iceland is twice unlucky here!

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Authors and Affiliations

  1. Norwegian Institute of International Affairs, Oslo, Norway

    Arne Melchior

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Melchior, A. (2018). How Important Is Trade? Estimates from a World Trade Model. In: Free Trade Agreements and Globalisation. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-92834-0_6

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  • DOI: https://doi.org/10.1007/978-3-319-92834-0_6

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