Gravity and Heterogeneous Trade Cost Elasticities

How do trade costs affect international trade? This paper offers a new approach. We rely on a flexible gravity equation that predicts variable trade cost elasticities, both across and within country pairs. We apply this framework to popular trade cost variables such as currency unions, trade agreements and World Trade Organization membership. While we estimate that these variables are associated with increased bilateral trade on average, we find substantial heterogeneity. Consistent with the predictions of our framework, trade cost effects are strong for ‘thin’ bilateral relationships characterised by small import shares, and weak or even zero for ‘thick’ relationships.