Disentangling Frictions across the World: Markups versus Trade Costs

Abstract
Standard methods to quantify how trade cost changes affect international trade abstract from market power. We develop a structural framework that allows us to quantify the evolution of aggregate bilateral trade costs and markups over time. With minimal assumptions, we can disentangle aggregate markup and trade cost changes from observed changes in trade flows. We apply our method to trade data between 1990 and 2015 for the world’s 100 largest economies. We find that across all country pairs, on average, bilateral aggregate markups have increased by 6.8% per year. Since bilateral aggregate trade costs have fallen, we find a strong negative correlation between observed trade cost and markup changes. Finally, our framework allows us to quantify how markups affect the welfare gains from trade liberalization. We find that, on average, welfare gains would be about a third larger if markups were constant. Joint paper with Benedikt Heid.