# **_Trade_**

Goods and services move within and across countries. Within each country, these flows are determined by the relative demand and supply of goods in each cell together with iceberg trade costs. � From the network data we derive iceberg trade cost factors τ�� , i.e. the cost of shipping goods from sector s across the transport network from origin cell i to destination j. The experiment we study is a � change in these costs. Internationally, in addition to network trade costs τ�� , there are country origin‐ destination shift parameters, A��� , which are sector specific, and capture national preferences for goods from other countries. For origins and destinations i, j both in the same country these take value unity. Between countries they may differ from unity but take a common value , A��� , for trade between all origin cells i in one country and destination cells j all in one other; i.e. for each sector s this is a block matrix, with values of A��� the same for any particular bilateral international trade.3 The parameter applies both for final consumption and intermediate usage of such goods. These shift parameters are calibrated such that international trade flows match the trade flows in the data. They apply only to international flows, since we only have trade data internationally, and they calibrated on top of the trade barriers created by the transport network.

The initial international trade flows are defined by the data, in which national trade balances are non‐ zero. We assume that net imports are paid for by remittances from migrants or other capital flows; the base levels of remittances/ capital flows do not change with the experiments, and neither therefore do national trade balances.

# **_Equilibrium and calibration_**

Given the transport network, endowments of labor and land, and parameters of the model (including � productivity parameters z�� and country origin‐destination shift parameters A�� ), the model generates, in each cell, prices for all goods, wages, and land rents such that markets clear. These prices shape the behavior of firms and the income levels and behavior of households, such that the associated levels of supply and demand are equal. The calibration sets values of productivity � parameters z�� and country origin‐destination shift parameters A�� such that equilibrium employment in each sector and cell matches the employment data, per capita incomes match country level income data, and international trade flows match the trade data.

# **_Simulations_**

The calibrated model is then ‘shocked’ with new transport times in the trade network, and firms and households adjust their decisions to optimally respond to the new geography of the region. We explore different degrees of response under combinations of five different assumptions which are, in summary:

- (1) Direct effect:  To quantify the scale of the shock we calculate transport cost savings at unchanged base level prices and quantities, i.e. take the transport cost reduction times the base value of exports from each cell to all other cells.<sup>4</sup> This allows us to observe the direct

> 3  If cells are grouped by country then the matrix of values of A��� is, for each s, a block matrix with common value A��� � A��� ,  for all i ε country c , j ε country k , and values unity on the block diagonal, i, j in the same country.

> 4  This is an ‘out of equilibrium’ calculation, designed purely to quantify the size of the initial shock.

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