Trade Growth in a Heterogeneous Firm Model: Evidence from South Easten Europe

In 2007 a Free Trade Area (BFTA) will be created in the Balkans. In this paper we study the potential impact of BFTA on trade growth in the SEE. Given that welfare impacts associated with trade growth depend on the growth channels, more goods and varieties exported or at higher price or higher volume of goods and varieties are exported, in this paper we investigate the structure of integration-induced export growth in the Balkans. The empirical implementation of our analysis is complicated by the fact that firm-level trade data is not available for the SEE economies. In order to cope with this data paucity, we adopt a heterogeneous firm framework, which allows us to decompose the aggregate trade growth in two parts: the intensive margin of trade and the extensive margin of trade using only aggregate trade data. The empirical findings of our study suggest that the BFTA would primarily trigger trade growth through a growing number of exported goods (the extensive margin of trade). Thus, the actual welfare gains from trade growth in the Balkans might be larger than predicted by previous trade studies. We also found that a variable trade cost reduction would lead to higher export growth rates compared to a fixed trade cost reduction. These results allow us to draw detailed policy conclusions.