Trade Costs and Gravity for Gross and Value Added Trade

Cross-border production fragmentation enables countries to export domestic value added not only directly in the form of gross exports of final goods, but also indirectly by participating in global supply chains. This paper studies the determinants of trade in value added. I incorporate the global input-output structure into an international trade model to derive an approximate gravity equation for bilateral value added exports. I quantify the effects of trade costs using the dataset constructed in Johnson and Noguera (2012), covering 42 countries over 1970-2009. I show that the bilateral trade cost elasticity of value added exports is about two-thirds of that for gross exports. Moreover, bilateral value added exports depend not only on bilateral trade costs but also on trade costs with third countries through which value added transits en route from source to destination. I show that the relative importance of these indirect effects varies significantly across countries and types of trade costs, and has increased over time alongside the rise in production fragmentation. ∗I am grateful to Donald Davis, Pierre-Olivier Gourinchas, Rob Johnson, Amit Khandelwal, Maury Obstfeld, Andrés Rodŕıguez-Clare, Jonathan Rose, Jonathan Vogel, Shang-Jin Wei, and David Weinstein for helpful discussions and comments. †Email: [email protected].