COMPUTING THE GAINS FROM TRADE: A SLIGHTLY TECHNICAL ASIDE
Building on this idea, we can compute the gains from trade. If the United States only imported bananas and produced apples, it would be fairly easy. We could look at the share of bananas in consumption, and the extent to which consumers were willing to switch between apples and bananas as the prices of bananas and apples changed.
(These are what economists call cross-price elasticities.) In fact, the United States imports products in about eighty-five hundred categories, so to do this calculation properly, we’d need to know the cross-price elasticity between every product and the price of every other product around the world—apples and bananas, Japanese cars and US soybeans, Costa Rican coffee and Chinese undershirts—making this approach unfeasible.But in fact we don’t actually need to look at products one by one. We can get reasonably close to the truth by assuming all imports are a single undifferentiated good that is either directly consumed (imports represent 8 percent of US consumption) or used as input for US production (another 3.4 percent of consumption).60
To get the final gains from trade, we need to know just how sensitive our imports are to trade costs. If they are very sensitive, it means it is easy to replace what we import with things we produce locally, and it is not very valuable to trade with other countries. If, on the other hand, the value remains unchanged even as the costs change, it means we really like what we buy abroad, and trade increases welfare a lot. There is some guessing involved here, since we are in fact talking about a good that does not exist, a composite of thousands of widely differing products. The authors therefore present the results for a range of situations, going from a scenario where traded goods can very easily be substituted with domestic goods (leading to gains of trade of 1 percent of GDP) to one where it is very difficult to substitute them (leading to an estimate of 4 percent of GDP).