Trade and Welfare Implications of Networks

This paper examines the effects on welfare and on patterns of trade of a reduction in costs of trading, such as might be the result of newly formed networks among residents of different countries with common culture or other ties. It argues that such a reduction in trade costs, even when it applies only to a particular bilateral trade route and may cause imports to be diverted from one source to another, must in the absence of distortions be welfare improving in the aggregate. On the other hand, such a change can indeed alter trade patterns distinctly, and they may also lower the welfare of particular countries. Examples are provided in which falling trade costs cause reversals of a country’s pattern of trade, and in which a country that becomes part of a trade-cost-reducing network that alters its trade loses as a result.