Recovering Credible Trade Elasticities from Incredible Trade Reforms

We study how trade-policy dynamics affect the dynamics of trade volumes and the implications of these effects for estimates of the trade elasticity. We use data on US imports and trade policy from 1974–2017 for China and Vietnam—the countries with the largest import growth and the largest tariff reductions over the last fifty years—and a heterogeneous-firm dynamic trade model to recover the dynamic path of the trade elasticity following an unanticipated, permanent tariff change. We estimate a short-run trade elasticity of about three and a long-run trade elasticity of about 14, and find that it takes about five years to close half of the gap between the current and long-run levels of trade. We argue that the expected dynamics of future trade policy before and after these reforms biases down reduced-form estimates of the long-run trade elasticity and biases up estimates of the short-run elasticity. We argue that these measurement issues are even more problematic for other trade reforms, especially those within the Normal Trade Relations (NTR) regime that constitute the majority of the data.