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I'm currently reading a paper about trade costs in international trade, but I really struggle to understand the following passage:

A rough estimate of the tax equivalent of “representative” trade costs for industrialized countries is 170 percent. This number breaks down as follows: 21 percent transportation costs, 44 percent border-related trade barriers, and 55 percent retail and wholesale distribution costs (2.7=1.21∗1.44∗1.55).

  1. What does "tax equivalent of representative trade costs" mean?
  2. "Trade costs for industrialized countries is 170 percent" of what?
  3. How can trade costs exceed 100%?

Please help me out, I'm really loosing my sleep on this one!

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The quotation comes from James Anderson and Eric Van Wincoop "Trade Costs" in the Journal of Economic Literature Vol. XLII (September 2004) pp. 691–75 and a preprint of the article is available

The calculation is trying to find the equivalent to an ad valorem tax by which the price of manufacture increases by the time of retail sale. Essentially it is saying transportation multiplies price by $1.21$ (a $21\%$ increase), tariff and non-tariff border related trade barriers multiply by $1.44$ (a $44\%$ increase), and retail and wholesale distribution costs multiply by $1.55$ (a $55\%$ increase) combining to multiply by $1.21\times 1.44\times 1.55=2.7$ (a $170\%$ increase).

This figure being over $100\%$ is not an issue. For example you could imagine a high tax on a packet of bottle of perfume costing $\$10$ before tax: if the tax rate was $170\%$ ad valorem this would add $\$17$ tax and make the after-tax price $\$27$.

There are plenty of caveats: domestic commerce also faces retail and wholesale distribution costs as well as some transport costs. Some goods see smaller costs, such as high-value low-weight goods seeing lower transport costs, or cross-border trade involving a short distance and a free-trade area, so this is in a sense a weighted average across goods and countries.

The article goes into considerable detail on the methods used for the calculations and possible implications for trade models.

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  • $\begingroup$ Thank you for your help @Henry! So, basically these costs are calculated on the value of the good and then added to it, right? Are they considered a tax equivalent because the increased price would make the good less attractive to potential costumers? $\endgroup$ – user10921 Oct 29 '16 at 13:15
  • $\begingroup$ It is an anology, but yes: higher extra costs make the traded goods less attractive to consumers, in a similar way to how a tax might $\endgroup$ – Henry Oct 29 '16 at 19:21

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