Diminishing Gains from Trade : A Macroeconomic Analysis

For a large class of structural gravity models in the literature, the gains from trade of a country increase with trade openness based on a common trade elasticity across countries. This paper shows that when the trade elasticity is allowed to be country specific and it increases with trade openness, it is possible for the gains from trade to decrease with trade openness under certain conditions, which we call as the diminishing gains from trade. In order to test this possibility, country-specific trade elasticity measures are estimated by using quarterly time-series data for 40 countries, where the model-implied macroeconomic relationship between the home expenditure share and the real income per capita is employed. The average trade elasticity is estimated about 2.7, with a range between 0.3 and 11.9 across countries. The corresponding gains from trade range between 4% and 65% across countries, with an average of about 30%. In a secondary cross-country analysis, the trade elasticity estimates are shown to increase and the gains from trade are shown to decrease with trade openness measures. It is implied that there are diminishing gains from trade with respect to trade openness