Infrastructure, transport costs and trade

This paper examines the role of infrastructure in a bilateral trade model with transport costs. Transport costs are assumed to depend inversely on the level of infrastructure. The accumulation of infrastructure, however, is subject to a resource cost technology which includes both fixed and variable components. It is shown that, depending on geography and endowments, equilibria with or without infrastructure can be obtained. For pairs of countries for which investment in infrastructure is optimal, the model predicts a positive relationship between the level of infrastructure and the volume of trade. The paper offers empirical evidence, utilising an augmented gravity model acid data from European countries, which strongly supports this prediction of the theory. (C) 1999 Elsevier Science B.V. Ail rights reserved.