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Most current modeling approaches identify very small gains from trade reform. In this chapter, we examine recent developments in the literature to assess whether standard modeling approaches are mis-specifying, understating, or overstating the gains from trade reform. Key areas where the impacts of trade barrier reduction appear to be understated include the measurement of barriers; the aggregation of these barriers; process productivity gains, particularly those resulting from reallocation of resources between firms; product quality improvements and expansion of product variety; factor supply; and investment of gains from trade.

This chapter presents a global computable general equilibrium model with firm heterogeneity based on the Melitz (2003) framework and examines the relative importance of the intensive and extensive margins in the trade expansion following trade liberalization. Using a set of plausible parameters values suggested by empirical studies and calibrating the model to the recent Global Trade Analysis Project (GTAP) global database, our illustrative simulations indicate that the extensive margin accounts for around one-third of the trade growth induced by a reduction in tariffs or variable trade costs. In the case of reducing fixed trade costs, the extensive margin contributes almost 200 percent of the trade expansion, with the intensive margin contributing negatively to trade growth.

The use of air cargo by low-income countries and the effects of freight charges on their export flows are described. This is accomplished by illustrating the difference between export flows from developing countries of perishable products and high-tech goods. Descriptive statistics are used to highlight the importance of trade that travels by air from these countries to the United States and the European Union. Subsequently, costs of air freight are estimated. A gravity model of trade measures the effect of these costs on export flows. Major institutional and regulatory constraints that may be halting additional trade that relies on air transportation, and the implications for economic growth, are identified.

This paper shows that consumer preference heterogeneity affects whether multinational firms serve local markets via imports or local production. Firms are least likely to choose local production over imports for product varieties that have relatively inelastic demand because transport costs have a smaller impact on the firm’s local profits for these products. The results suggest that there is complementarity between centralized production, with local market access via imports, and strategies that maintain low price elasticities at the brand level, such as advertising and within-brand product proliferation. A partial equilibrium study of the laundry detergent industry in Western Europe illustrates how firms and consumers interact at different levels of transport costs and reveals the product varieties that are most and least likely to be manufactured locally when transport costs are high.

The existence of parallel imports (PI) raises a number of interesting policy and strategic questions, which are the subject of this survey article. For example, parallel trade is essentially arbitrage within policy-integrated markets of IPR-protected goods, which may have different prices across countries. Thus, we analyze fully two types of price differences that give rise to such arbitrage. First is simple retail-level trade in horizontal markets because consumer prices may differ. Second is the deeper, and more strategic, issue of vertical pricing within the common distribution organization of an original manufacturer selling its goods through wholesale distributors in different markets. This vertical price control problem presents the IPR-holding firm a menu of strategic choices regarding how to compete with PI. Another strategic question is how the existence of PI might affect incentives of IPR holders to invest in research and development (R&D). The global research-based pharmaceutical firms, for example, strongly oppose any relaxation of restrictions against PI of drugs into the United States, arguing that the potential reduction in profits would diminish their ability to innovate. There is a close linkage here with price controls for medicines, which are a key component of national health policies but can give rise to arbitrage through PI. We also discuss the complex economic relationships between PI and other forms of competition policy, or attempts to limit the abuse of market power offered by patents and copyrights. Finally, we review the emerging literature on how policies governing PI may affect international trade agreements.

Two fundamental reasons that account for the domestic bias of consumption are distance and borders. Distance proxies for unobservable trading costs, which include, among other things, transport and administrative costs. Distance is a powerful deterrent to international trade. This fact is illustrated by considering the situation of Bahrain and Qatar, Belgium and India, and Indonesia and Guyana, which are, respectively, the closest (55.5mi), the median (4,414.7mi), and the farthest (12,351.1mi) country pairs in a large sample of bilateral trade flows (see Chapter 2). For Bahrain and Qatar, distance is estimated to reduce the estimate of bilateral trade flows by 39%; for Belgium and India, the reduction is 58%; for Indonesia and Guyana, the reduction is 121% (it exceeds the value of bilateral transactions). The success of the gravity model in explaining bilateral trade flows is due, to no small measure, to distance. For example, the standard trade model of complete specialization, without trading costs, makes two strong predictions. The first is that a country will import goods from all other countries in the world and the second that bilateral trade flows are proportional to the income of the two countries. Both predictions are way off the mark. Countries import from a small fraction of the potential pool of exporters and incomes alone over-predict actual trade flows by a large margin.

Purpose – The present note shows the interaction between technological differences between countries and the level of trade costs as a determinant of trade patterns.

Methodology/approach – It takes the work of Kikuchi et al.'s (2008) Chamberlinian–Ricardian model as its point of departure, and extends the analysis to include both a continuum of industries, as did Dornbusch et al. (1977), and iceberg transport costs.

Findings – It will be shown that trade liberalization drastically changes the nature of trade patterns, particularly the emergence of intra-industry trade.

Originality/value – This present model extends the Chamberlinian–Ricardian model to include positive trade costs.

This chapter provides a theory model of trade finance to explain the “great trade collapse.” The model shows that, first, the riskiness of international transactions rises relative to domestic transactions during economic downturns; and second, the exclusive use of a letter of credit in international transactions exacerbates a collapse in trade during a financial crisis. The basic model considers banks’ optimal screening decisions in the presence of counterparty default risks. In equilibrium, banks will maintain a higher precision screening test for domestic firms and a lower precision screening test for foreign firms, which constitutes the main mechanism of the model.

We develop a simple two-country model of international trade that assumes that there is a fixed cost of doing international trade. We show that this leads to multiple equilibria that can be Pareto-ranked. We examine the stability properties of these equilibria.