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Per-Capita Income and the Extensive Margin of Bilateral Trade: A Quantitative Ricardian Model
wiiw Seminar in International Economics ,
This paper develops a Ricardian trade model that accounts for the empirically observed positive relation between the extensive margin of a bilateral trade flow (measured as the number of goods categories with positive volumes) and the per-capita incomes of the trading partners. The central mechanism is that richer agents consume a wider set of varieties, which leads to a positive relation between per-capita income of the importer and the extensive margin. The positive effect of exporter per-capita income, corresponding to the standard model, comes from the fact that technologically advanced countries are the cheapest suppliers for many varieties. Using aggregate trade volumes and US consumption data we calibrate the new model and find that it captures remarkably well the behavior of the extensive margin of trade. For example the importer income elasticity of the extensive margin is 0.54 in the data, whereas our model produces an elasticity of 0.48 (in contrast to -0.40 in the standard model). We conclude the paper with two counterfactual experiments that highlight the quantitative importance of per-capita incomes in determining the extensive margin of trade.