Scale Economies in European Trade

Using the gravity framework, I study scale elasticities in European trade costs, which capture how much trade costs are negatively associated with trade volumes. Their presence implies that trade costs respond to the intensity and frequency of trade interactions and suggests that reducing fixed institutional trade barriers may generate positive effects on bilateral trade. Across nine manufacturing macro-sectors and over a forty-year time span, I find strong evidence of economies of scale in trade costs in Europe: on average, a 10% increase in bilateral trade volume is associated with a 1.07% reduction in trade costs. I find that the European Union expansion affected scale elasticities, consistent with an overall reduction in fixed trade costs, though this decrease is negligible. Country-specific institutional variables, such as the partner’s level of corruption, play a role: exporting to the most corrupted country in the sample entails an 80% higher gain from additional trade volume than exporting to the least corrupted one.