Working Paper: CEPR ID: DP18421
Authors: Peter Egger; Reto Foellmi; Ulrich Schetter; David Torun
Abstract: Countries trade more if they liberalized their trade relationship earlier. We derive a gravity equation featuring this path dependence due to sunk market-access costs that generate incumbency effects. We provide supporting evidence for the underlying mechanism and derive an augmented ACR formula (Arkolakis et al., 2012) for the gains from trade that accounts for incumbency effects. A quantification suggests our mechanism explains up to 25% of countries’ home shares, and the gains from trade are, on average, 10% larger when allowing for incumbency effects. The analysis further reveals novel distributional effects of trade, boosting real wages but reducing profits.
Keywords: incumbency effects; sunk cost of market access; gravity equation; gains from trade; home bias; path dependence
JEL Codes: F12; F14; F15; F17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Timing of trade liberalization (F13) | Current trade volumes (F19) |
| Incumbency effects (D72) | Home shares in trade (D16) |
| Trade liberalizations (F13) | Real wages (J31) |
| Trade liberalizations (F13) | Profits (D33) |
| Historical trade barriers (F14) | Current trade flows (F19) |
| Trade shocks (F14) | Firm exit behavior (D21) |