Foreign and Domestic Trade Costs, Product Variety, and the Standard of Living Across Countries

Alberto  Cavallo; Robert C. Feenstra; Robert  Inklaar

Mimeo | 2018

Foreign and Domestic Trade Costs, Product Variety, and the Standard of Living Across Countries

by Alberto Cavallo, Robert C. Feenstra and Robert Inklaar

Abstract

We extend the analysis of Arkolakis, Costinot and Rodríguez-Clare (AER, 2012) to allow for differences in domestic trade costs in addition to foreign trade costs. The domestic trade costs are measured by local transportation charges and wholesaling and retailing margins. By allowing for differences in domestic trade costs, as well as in country size, productivity and in fixed costs, we are able to model both the welfare change between two equilibria and the welfare difference between two countries. We find that the extended ACR formula depends on: (a) the share of expenditure on domestic goods (reflecting in part foreign trade costs); (b) domestic trade costs; (c) the extent of product variety available to consumers. We measure the extent to which differences in the cost of living between countries are explained by these terms. We find that domestic trade costs are of comparable importance to foreign trade costs and that differences in product variety are notably more important than both of these.

Keywords: Economics; Trade; Cost;

Language: English

Format: Print

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Citation:

Cavallo, Alberto, Robert C. Feenstra, and Robert Inklaar. "Foreign and Domestic Trade Costs, Product Variety, and the Standard of Living Across Countries." 2018. Mimeo.

In early 2020, a coronavirus pandemic swept the globe, ushering in unprecedented disruptions to the global economy. Both supply and demand were decimated by lockdowns and border closings, as well as reduced spending by fearful consumers. In response, governments around the world made equally unprecedented policy moves, spending trillions of dollars on fiscal stimulus measures to bridge the gap during the self-imposed shutdown. As the pandemic progressed, governments had to weigh the costs between loss of life due to opening up their economies and the economic devastation caused by delaying a reopening.

The Covid-19 Pandemic has led to changes in consumer expenditure patterns that can introduce significant bias in the measurement of inflation. I use data collected from credit and debit transactions in the US to update the official basket weights and estimate the impact on the Consumer Price Index (CPI). I find that the Covid inflation rate is higher than the official CPI in the US, for both headline and core indices. I also find similar results with Covid baskets in 12 out of 17 additional countries. The difference is significant and growing over time, as social-distancing rules and behaviors are making consumers spend relatively more on food and other categories with rising inflation, and relatively less on transportation and other categories experiencing significant deflation.

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Foreign and Domestic Trade Costs, Product Variety, and the Standard of Living Across Countries

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