Can Multi-Stage Production Explain the Home Bias in Trade?

41 Pages Posted: 1 Jul 2008

See all articles by Kei-Mu Yi

Kei-Mu Yi

University of Houston - Department of Economics; Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Date Written: June 2008

Abstract

A large empirical literature finds that there is too little international trade, and too much intra-national trade to be rationalized by observed international trade costs such as tariffs and transport costs. The literature uses frameworks in which goods are assumed to be produced in just one stage. This paper investigates whether the multi-stage nature of production helps explain the home bias in trade. The author shows that multi-stage production magnifies the effects of trade costs. He then calibrates a multi-stage production model to the U.S. and Canada. He solves the model with measures of trade costs constructed from data on tariffs, transport costs, and wholesale distribution margins. The model can explain about 3/8 of the Canada border effect; this is three times more than what a calibrated one-stage model can explain. The model also explains a good deal of Canada's vertical specialization trade. Finally, a reverse engineering exercise suggests that the unknown or unobserved component of trade costs is smaller than observed trade costs.

Keywords: border effect, multi-stage production, trade costs, U.S.-Canada trade, vertical specialization, calibration, home bias in international trade

JEL Classification: F1, F4

Suggested Citation

Yi, Kei-Mu, Can Multi-Stage Production Explain the Home Bias in Trade? (June 2008). FRB of Philadelphia Working Paper No. 08-12. Available at SSRN: https://ssrn.com/abstract=1150912 or http://dx.doi.org/10.2139/ssrn.1150912

Kei-Mu Yi (Contact Author)

University of Houston - Department of Economics

Houston, TX 77204-5882
United States

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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