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Structural gravity with dummies only: Constrained ANOVA-type estimation of gravity models

Listed author(s):
  • Egger, Peter H.
  • Nigai, Sergey

The measurement of trade costs and their effects on outcome is at the heart of a large quantitative literature in international economics. The majority of the recent significant contributions on the matter assumes that trade is log-linear in exporter-specific factors, importer-specific factors, and log trade costs that are additively composed of a parameterized part and a residual part. We demonstrate that, under standard assumptions in the literature, the magnitude of unobservable, residual trade costs is large, and that their ignorance leads to a bias of the importance of observable trade-cost measures as well as of country-specific variables that are either solved implicitly through structural estimation or estimated explicitly as fixed effects. The reason is that, due to general-equilibrium linkages, some country-specific variables are endogenous to residual trade costs, regardless of whether they are captured by iteratively-solved structural terms or by country(-time) fixed effects. As a result, quantifications of effects of trade costs and comparative static results are also biased. Apart from diagnosing this problem, the paper provides remedies for it by proposing theory-consistent approaches including a two-step procedure that permits identifying partial effects of observable gravity variables on total trade costs and trade flows which do not suffer from the unobserved-trade-cost bias.

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File URL: http://www.sciencedirect.com/science/article/pii/S0022199615001014
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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 97 (2015)
Issue (Month): 1 ()
Pages: 86-99

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Handle: RePEc:eee:inecon:v:97:y:2015:i:1:p:86-99
DOI: 10.1016/j.jinteco.2015.05.004
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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