Trade, Domestic Frictions, and Scale Effects

65 Pages Posted: 11 Nov 2012 Last revised: 20 Feb 2022

See all articles by Natalia Ramondo

Natalia Ramondo

Arizona State University

Andrés Rodríguez-Clare

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Milagro Saborio-Rodriguez

College of Agricultural Sciences, Department of Agricultural Economics and Rural Sociology

Date Written: November 2012

Abstract

Because of scale effects, idea-based growth models have the counterfactual implication that larger countries should be much richer than smaller ones. New trade models share this same problematic feature: although small countries gain more from trade than large ones, this is not strong enough to offset the underlying scale effects. In fact, new trade models exhibit other counterfactual implications associated with scale effects – in particular, domestic trade shares and relative income levels increase too steeply with country size. We argue that these implications are largely a result of the standard assumption that countries are fully integrated domestically, as if they were a single dot in space. We depart from this assumption by treating countries as collections of regions that face positive costs to trade amongst themselves. The resulting model is largely consistent with the data. For example, for a small and rich country like Denmark, our calibrated model implies a real per-capita income of 81 percent the United States’s, much closer to the data (94 percent) than the trade model with no domestic frictions (40 percent).

Suggested Citation

Ramondo, Natalia and Rodríguez-Clare, Andrés and Saborio-Rodriguez, Milagro, Trade, Domestic Frictions, and Scale Effects (November 2012). NBER Working Paper No. w18532, Available at SSRN: https://ssrn.com/abstract=2173632

Natalia Ramondo (Contact Author)

Arizona State University ( email )

Tempe, AZ 85287-3806
United States

Andrés Rodríguez-Clare

University of California, Berkeley - Department of Economics ( email )

579 Evans Hall
Berkeley, CA 94709
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Milagro Saborio-Rodriguez

College of Agricultural Sciences, Department of Agricultural Economics and Rural Sociology ( email )

University Park, PA 16802-3306
United States

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