Income , Trade Barriers , and International Trade ∗

Abstract

This paper argues that when rich countries export, per capita income differences with the trading partner act as trade barriers. I develop and quantify a multi-country general equilibrium model with non-homothetic preferences and heterogenous firms with no fixed trade barriers. In my model, per capita income level is a key determinant of trade patterns. With non-homothetic preferences, countries, depending on their income, potentially demand different sets of varieties as well as different quantities for a given variety. As a result, rich countries have different demand patterns than poor countries, and trade between rich countries is more intense. I compare my model with a benchmark model with homothetic preferences and bilateral fixed trade barriers. For rich countries the estimated variable trade barriers for exporting to other rich countries are lower in the benchmark model than in my model. Conversely, for rich countries the estimated variable trade barriers for exporting to poor countries are higher in the benchmark model than in my model. A quantitative comparison between the two models shows that they predict similar trade patterns even with different estimated inputs for the variable trade barriers, implying that when rich countries export, income differences with the trading partner in my model play a similar role as additional trade barriers in the benchmark model. The model with non-homothetic preferences generates unit price variation across different import markets conditional on same exporter and variety while the standard models do not. ∗I am grateful to Timothy J. Kehoe, Fabrizio Perri, and Cristina Arellano for their support and advice. I also thank Costas Arkolakis, V.V. Chari, John T. Dalton, Alessandra Fogli, Ellen R. McGrattan, Micheal Waugh and the members of the Trade and Development workshop at the University of Minnesota for their suggestions and comments. I have also benefited from comments from seminar participants at the Federal Reserve Bank of Minneapolis. All errors are mine. †Contact: Department of Economics, University of Minnesota, 4-101 Hanson Hall, 1925 Fourth Street South, Minneapolis, MN 55455. Email: gturkmen@econ.umn.edu.