Does convergence cause trade, or does trade cause convergence?

This paper examines the direction of causality between international trade and cross-country income differences in several ways. First, instruments for income are used in pooled gravity regressions to determine the effect of income differences on bilateral trade, and instruments for trade are used in regressions to determine the causes of income dispersion. Results of these cross-country estimations show that more similar countries trade more, while trade appears to increase dispersion. However, fixed-effects regression, random-effects regression, and Granger causality tests show that trade reduces income differences over time. Thus, while the postwar era has seen increasing trade and conditional convergence, the causality is bi-directional: convergence causes trade, and trade causes convergence.