Chapter 3: Trade costs
The critical role played by trade costs in determining the volume and direction of trade flows, in understanding the level of foreign direct investment or firm outsourcing and the increasing popularity of trade agreements in the history of trade relations among nations has engaged the attention of trade economists since the beginning of the 1960s. More recently, the importance of non-policy barriers (such as inadequate transport infrastructure and trade logistics) and trade policies (in the form of trade agreements) to bilateral trade flows has come up for debate. Studies have investigated the importance of such non-policy barriers and trade policies on trade flows of different countries at different points in time or over time. Most of these studies have relied on the gravity model (the ‘workhorse’ of international trade) as the basis of the analysis. Trade costs include all costs (other than the marginal cost of producing the good) incurred in getting a good from the producer to the final user. Within the trade literature trade costs have been classified as arising mainly from two sources: natural and artificial sources. Natural trade costs refer to costs incurred mainly as a result of how countries are distributed (i.e. geography). This includes costs related to distance (that is, transportation), country-specific costs and time. Artificial trade costs are those that are incurred as a result of public policy and other factors.
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