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Gravity-defying trade

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  • J. M. C. Santos Silva
  • Silvana Tenreyro

Abstract

Heteroskedasticity and the existence of zero values in bilateral-trade data lead to significant biases in standard estimations of the gravity equation. We propose a new estimation technique that addresses these problems, and provide novel estimates of the gravity equation. Three results stand out. First, contrary to general belief, income elasticities are significantly smaller than 1, suggesting modifications to standard trade models. Second, simple estimators of the gravity equation greatly exaggerate the roles of distance and colonial links. Finally, bilateral trade between countries that have signed a free-trade agreement is 30 percent larger than that between other countries, a magnitude remarkably different from that predicted by conventional methods (above 100 percent).

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 03-1.

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Date of creation: 2003
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Handle: RePEc:fip:fedbwp:03-1

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Keywords: Free trade;

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References

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  1. Silvana Tenreyro & Robert J. Barro, 2003. "Economic Effects of Currency Unions," NBER Working Papers 9435, National Bureau of Economic Research, Inc.
  2. James E. Anderson & Eric van Wincoop, 2000. "Gravity with Gravitas: A Solution to the Border Puzzle," Boston College Working Papers in Economics 485, Boston College Department of Economics.
  3. Peter Egger, . "An Econometric View on the Estimation of Gravity Models and the Calculation of Trade Potentials," WIFO Working Papers 141, WIFO.
  4. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  5. Andrew K. Rose, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," NBER Working Papers 7432, National Bureau of Economic Research, Inc.
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  7. Manning, Willard G. & Mullahy, John, 2001. "Estimating log models: to transform or not to transform?," Journal of Health Economics, Elsevier, vol. 20(4), pages 461-494, July.
  8. Jeffrey A. Frankel and Shang-Jin Wei., 1993. "Emerging Currency Blocs," Center for International and Development Economics Research (CIDER) Working Papers C93-026, University of California at Berkeley.
  9. Frankel, Jeffrey & Rose, Andrew K., 2001. "An Estimate of the Effect of Common Currencies on Trade and Income," Working Paper Series rwp01-013, Harvard University, John F. Kennedy School of Government.
  10. Barro, Robert & Alesina, Alberto, 2002. "Currency Unions," Scholarly Articles 4551795, Harvard University Department of Economics.
  11. Robert C. Feenstra & James R. Markusen & Andrew K. Rose, 2001. "Using the gravity equation to differentiate among alternative theories of trade," Canadian Journal of Economics, Canadian Economics Association, vol. 34(2), pages 430-447, May.
  12. Bergstrand, Jeffrey H, 1985. "The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 474-81, August.
  13. Jon Haveman & David Hummels, 2004. "Alternative hypotheses and the volume of trade: the gravity equation and the extent of specialization," Canadian Journal of Economics, Canadian Economics Association, vol. 37(1), pages 199-218, February.
  14. Davis, Donald R., 1995. "Intra-industry trade: A Heckscher-Ohlin-Ricardo approach," Journal of International Economics, Elsevier, vol. 39(3-4), pages 201-226, November.
  15. Jeffrey A. Frankel, 1997. "Regional Trading Blocs in the World Economic System," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 72.
  16. Loeb, Susanna & Bound, John, 1996. "The Effect of Measured School Inputs on Academic Achievement: Evidence form the 1920s, 1930s and 1940s Birth Cohorts," The Review of Economics and Statistics, MIT Press, vol. 78(4), pages 653-64, November.
  17. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-16, March.
  18. Peter Egger, . "A Note on the Proper Econometric Specification of the Gravity Equation," WIFO Working Papers 108, WIFO.
  19. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-23, June.
  20. Gourieroux Christian & Monfort Alain & Trognon A, 1982. "Pseudo maximum lilelihood methods : applications to poisson models," CEPREMAP Working Papers (Couverture Orange) 8203, CEPREMAP.
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