Nonparametric Counterfactual Predictions in Neoclassical Models of International Trade

Abstract

We develop a methodology to construct nonparametric counterfactual predictions, free of functional-form restrictions on preferences and technology, in neoclassical models of international trade. First, we establish the equivalence between such models and reduced exchange models in which countries directly exchange factor services. This equivalence implies that, for an arbitrary change in trade costs, counterfactual changes in the factor content of trade, factor prices, and welfare only depend on the shape of a reduced factor demand system. Second, we provide sufficient conditions under which estimates of this system can be recovered nonparametrically. Together, these results offer a strict generalization of the parametric approach used in so-called gravity models. Finally, we use China's recent integration into the world economy to illustrate the feasibility and potential benefits of our approach.

The US Gains From Trade: Valuation Using the Demand for Foreign Factor Services

“…Recently, Adao, Costinot, and Donaldson (2017) proposed an approach to reduce the dimensionality of what is required for counterfactual analysis in general, and the measurement of the gains from trade in particular.…”

“…It should be clear, however, that the approach of Adao, Costinot, and Donaldson (2017) does not hinge on the assumption, common in the trade literature, that there are more goods than factors. The critical observation to reduce the dimensionality of what needs to be estimated is that knowledge of the reduced demand for factors is sufficient to measure the gains from trade; separate knowledge of demand for goods, by consumers and firms, and demand for factors, by firms, is not required.…”

“…11 11 In models with input-output loops, such as Alvarez and Lucas (2007), this means that the relevant price of foreign factor services is not the price of foreign value added, but the price of the bundle of inputs required for production abroad, a bundle that combines foreign value added with domestic value added, through imports of intermediate goods abroad. Once this adjustment is made, again using the World Input-Output Database, the difference turns out to be small: for example, in the year 2014, the import ratio for the US increases from 11.4 to 12.1 percent, and similar results hold for the rest of the countries.…”

“…Adao, Costinot, and Donaldson (2017) have proposed a strict generalization of the constant elasticity of substitution assumption inspired by the work of Berry, Levinsohn, and Pakes (1995) in the field of industrial organization. Their "mixed CES" demand system allows the degree of substitutability across factor services from different countries to vary systematically with observable characteristics of those countries.…”

Trade Costs, CO2, and the Environment

“…I use the notation θ j ≡ 1 − σ j to highlight that the elasticity in equation (6a) does not merely represent a preference parameter, but represents the key trade elasticity of a large family of gravity models. 3 Profit maximization and utility maximization imply the following expenditure:…”