Three essays on trade costs and national borders
Individuals of the same country buy and sell from each other far more than they do with individuals of a different country. A cost is associated with exchanging goods and service across national boundaries. Economists have had difficulty, however, in reconciling the small observable trade frictions with the very large trade reducing effect of borders. In the first chapter of this thesis, we propose an explanation which explains a great deal of the border puzzle between the United States and Canada. Few observable trade frictions exist which prevent the buying and selling of goods across this border, yet Canadian provinces and American states trade far more with themselves than they do with each other. Using a novel data set on Facebook friendship connections between North American regions, we uncover a substantial home bias in social linkages between the United States and Canada. Simply put, Canadians and Americans do not know each other very well. Social networks are important for trade in that they reduce information costs and increase the efficacy of informal trust mechanisms. We find that including social linkages in a gravity model substantially mediates the effect of the US-Canada border on trade. In the second chapter of this thesis, we focus on how trade costs are formed. Workhorse models of international trade typically assume, for great simplicity, that trade costs are exogenous to trade. We present a model in which the act of trading affects the cost of trade and vice versa. We focus on the trade cost associated with informal trust mechanisms. A great deal of evidence exists which shows that ceteris paribus, countries that trust each other trade far more with each other. In our model, trust is a necessary condition for trade to exist, but trust can only be formed through repeated interaction. This creates a supermodular game between would-be traders of the same country. Broadly speaking, two equilibria exist in this game. One with trust and trade, and one without trust and without trade. This framework highlights the importance of trade missions as a coordinating device. In the final chapter, based on a joint work, we assess the welfare implications of political separation. Because borders dramatically reduce trade, what happens when national borders are created when they once did not exist? The focus of this chapter is on the Basque Country in Spain, in which there is a strong pressure for full political separation. While it is certainly difficult to say what exactly would happen to the cost of trading between the Basque Country and the rest of Spain if political separation occurred, we use the cost of trade between Portugal and Spain as a benchmark. That is, we ask what the welfare implications would be if the cost of trade between the Basque Country and the rest of Spain were equal to the cost of trade between Portugal and Spain. We find that increasing trade costs in this manner would decrease the Basque Country's real income by more than 12%.