Gains from trade: International transport costs are still important

Gains from trade: International transport costs are still important, especially in addition

Transportation costs have decreased significantly thanks to technological advances in transportation, infrastructure development, and new communication technologies. From 1850 to 2020, maritime transport costs fell by 79% (Jacques and Stuermer 2021). Nevertheless, international transport costs are far from negligible. About 20 years ago, Anderson and van Wynkoop (2004) noted that transportation costs still represent about 30% of international trade costs (the rest being made up of transaction costs, policy costs and time costs). Disdier and Head (2008) also highlight that distance (a natural proxy for transport costs) is still a very important determinant of trade flows. More recently, the Covid-19 pandemic had a huge impact: transpacific freight rates at the end of 2021 were eight to nine times higher than the pre-pandemic norm (Waters 2021). Transportation costs are with us and worth studying.

Having a clear view of the burden of international transport costs is important for a number of important economic issues, such as the gains from reduced trade costs. The usual way of modeling transport costs is to assume that they are appreciable, i.e. proportional to the value of the goods traded. Because they are qualitative, such costs do not distort relative value. Nevertheless, this assumption contradicts the daily evidence of shipping price schedules depending on volume and weight. Considering its existence Addition costs which is not proportional to the value of traded goods and therefore challenges some received wisdom in international trade by distorting relative value. In this column, we argue that added costs are quantitatively large and point to their impact on two dimensions: the role of composition effects in reducing transport costs and in international trade welfare calculations.

Additive costs are important

Although much of the international trade literature models trade costs as equivalent to ad valorem taxes – i.e. as a fixed percentage of the producer price per unit traded, part of Samuelson’s (1954) ‘iceberg cost’ hypothesis – recent papers point to the existence of an additive component, Trade is dependent on physical quantity (Irazabal et al. 2015, Martin 2012; but see the opposite view of Laskaripour 2020). How big is the additive component of international transport costs? Based on US import data, we break down imports by sector (at the three- and four-digit level, as well as HS10), country of origin, and mode of transport (air and sea transport) on an annual basis for 1974–2019 (Daudin et al. 2022).

The added transportation costs are huge. Between 1974-2019, we estimate that they account for 1.7% and 2.8% of ‘free ship’ (fas) export value in air and ship transport, respectively. These estimates are slightly lower than the ad-valorem component, which is 2.4% in air transport and 3% in ships. On average, added costs represent between 30% (in air transport) and 45% (by road) of total transport costs.

Figure 1 shows the estimated cost share of transportation costs added during this period. The additive component appears prominently throughout the period in both transport modes. It varies significantly over time with a different pattern across transport modes. After the general growth of air and ship from the mid-1970s to the late 1980s, the share of additive components in air transport has steadily declined. In contrast, it continued to increase until the 2000s for ships. Put differently, the decrease in total transportation costs is mostly due to reductions in added costs in air transportation, while it is mainly driven by reductions in ad-valorem costs in shipping. These results hold across a variety of empirical settings, including the use of instrumental variables and more discrete data.

Figure 1 Cost share of total transportation costs added to US imports

Disagree: The dashed line is the quadratic trend.

Deepening the reduction of international transport costs over time

Overall, we see that both air and ship have exhibited a downward trend in total transport costs (as a percentage of export value) since 1974, averaging roughly the same magnitude of -2% per year (equivalently, a 60% decrease). This reduction in aggregate transport costs may be due to a reduction in ‘pure’ transport costs or changes in the mix of trade (ie changes over time in the basket of imported goods and source countries). We address both explanations by decomposing transport cost trends into two ‘composition’ and ‘pure transport cost’ effects (see Figure 2). We find that the decline in ‘pure’ transport costs (ie for a given sector/country partner) accounts for most of the downward trend in international transport costs over time, 50% to 60%. Trade composition effects have only a limited effect and when they do, they tend to reduce pure transport costs. This conclusion stands in contrast with Hummels (2007). Investigating this difference further, we show that modeling the additive component as varying over time, country partner and product is key to the accurate characterization of international transport cost trend patterns (Daudin et al. 2022).

Figure 2 Composition effect to reduce transportation cost

Disagree: Transport costs are expressed as a percentage of the value shipped, then indexed in 1974 with a reference value of 100.

Welfare effects

Because additive transport costs distort relative prices, they will impose a greater burden on welfare than ad valorem costs. To investigate that issue over the period 1974–2019, we introduce additive costs into the canonical Melitz (2003) model.

Table 1 summarizes our main findings. Reported reductions in transportation costs are based on our empirical estimates between 1974 and 2019. In carrying out this exercise, we also take into account the fact that the share of exporting firms has increased significantly in the United States during the period of interest (today equal to 39% according to Lincoln and McCallum 2018). This can be accounted for in the model by an appropriate reduction in the fixed cost of exports. For both transport modes (air and ship), we contrast two cases: when the reduction in transport costs occurs only through a reduction in ad-valorem costs, as typically modeled in New Trade theory (figures in columns A and C), versus when it is ad-valorem costs. -achieved by the combined reduction of valorem and additive components, as measured by our experimental practice (figures in columns B and D).

Table No. 1 Reducing Trade Costs: The Role of Added Costs

Disagree: Table taken from Daudin et al. (2022). TC = Transportation cost, expressed as a percentage of the average export fs value. τ and t stand for ad-valorem and additive cost respectively. The reduction in transportation costs is expressed in percentage points. β is the share of added costs in total transportation costs. ∆W⁄W measures the welfare gain (or loss).

For both transport modes, the welfare gains associated with reductions in transport costs are greater when these reductions are partly achieved through reductions in added costs. Accounting for added costs, a 14% reduction in ship and 40% in air transport increases the welfare gains in transport costs. Ignoring the added costs leads to a significant underestimation of the welfare gains of globalization.

What is the underlying mechanism? In the canonical case with only ad-valorem costs, the welfare gains from reduced transport costs can be seen as the result of two opposite effects. As lower trade costs intensify competition from foreign firms, entry into domestic markets becomes more difficult. This reduces the number of varieties accessible to consumers, hence welfare. However, since firms serving domestic markets (local or foreign) are also more productive due to strict selection, consumers benefit from lower prices. This price effect dominates, and the reduction in transport costs benefits the welfare.

What changes when international transportation costs are reduced by reducing its additive component? The key factor is that reductions in added costs change relative prices. A reduction in the cost of addition actually implies that the export-market value of high-productivity exporters decreases relative to low-productivity ones (Sorensen 2014). In other words, a reduction in added costs induces a selection effect among exporters in favor of more productive firms. This amplifies the classic Melitz (2003) selection effect by a wide margin. Both the (positive) price effect and the (negative) diversification effect are strong, but the former dominates, inducing greater welfare gains than pure ad-valorem.

Additive costs are important in international transport costs. Recognizing this has important consequences for the study of recent ‘hyper-globalization’ periods. Descriptively, this allows for better characterization of trend patterns in international transport costs. Namely, declines in ‘pure’ transport costs account for most of the overall decline observed in 1974–2019. In theory, the welfare gains from reductions in transport costs are significantly larger when their cumulative magnitude is considered. This calls for further exploration of the role of added costs, for example in the formation of international trade flows and in the international transmission of business cycles.

reference

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