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Aggregation and the Gravity Equation

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  • Stephen J. Redding
  • David E. Weinstein

Abstract

One of the most successful empirical relationships in international trade is the gravity equation, which relates bilateral trade flows between an origin and destination to bilateral trade frictions, origin characteristics, and destination characteristics. A key decision for researchers in estimating this relationship is the level of aggregation, since the gravity equation is log linear, whereas aggregation involves summing the level rather than the log level of trade flows. In this paper, we derive an exact Jensen's inequality correction term for the gravity equation in a nested constant elasticity of substitution (CES) import demand system, such that a log-linear gravity equation holds exactly for each nest of this demand system. We use this result to decompose the effect of distance on bilateral trade in the aggregate gravity equation into the contribution of a number of different terms from sectoral gravity equations. We show that changes in sectoral composition make a quantitatively relevant contribution towards the aggregate effect of distance, particularly for more disaggregated definitions of sectors.

Suggested Citation

  • Stephen J. Redding & David E. Weinstein, 2019. "Aggregation and the Gravity Equation," CEP Discussion Papers dp1595, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp1595
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    References listed on IDEAS

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    1. Heblich, Stephan & Redding, Stephen J. & Sturm, Daniel M, 2018. "The Making of the Modern Metropolis: Evidence from London," CEPR Discussion Papers 13170, C.E.P.R. Discussion Papers.
    2. Natalia Ramondo & Andrés Rodríguez-Clare & Milagro Saborío-Rodríguez, 2016. "Trade, Domestic Frictions, and Scale Effects," American Economic Review, American Economic Association, vol. 106(10), pages 3159-3184, October.
    3. Gabriel M. Ahlfeldt & Stephen J. Redding & Daniel M. Sturm & Nikolaus Wolf, 2015. "The Economics of Density: Evidence From the Berlin Wall," Econometrica, Econometric Society, vol. 83, pages 2127-2189, November.
    4. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
    5. Combes, Pierre-Philippe & Lafourcade, Miren & Mayer, Thierry, 2005. "The trade-creating effects of business and social networks: evidence from France," Journal of International Economics, Elsevier, vol. 66(1), pages 1-29, May.
    6. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    7. Arnaud Costinot & Dave Donaldson & Ivana Komunjer, 2012. "What Goods Do Countries Trade? A Quantitative Exploration of Ricardo's Ideas," Review of Economic Studies, Oxford University Press, vol. 79(2), pages 581-608.
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    Citations

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    Cited by:

    1. Bee Yan Aw & Yi Lee & Hylke Vandenbussche, 2019. "The importance of consumer taste in trade," CESifo Working Paper Series 7580, CESifo Group Munich.
    2. Aw-Roberts, Bee Yan & Lee, Yi & Vandenbussche, Hylke, 2019. "The Importance of Consumer Taste in Trade," CEPR Discussion Papers 13614, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    gravity equation; trade; aggregation;

    JEL classification:

    • F10 - International Economics - - Trade - - - General
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation

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