IDEAS home Printed from https://ideas.repec.org/p/cfg/cfigwp/15.html
   My bibliography  Save this paper

Gravity or Dummies? The Limits of Identification in Gravity Estimations

Author

Listed:
  • Cecília Hornok

Abstract

Trade economists often estimate gravity equations of international trade with fixed effects. Anderson and van Wincoop (2003, American Economic Review 93, 170–192) have shown the importance of controlling for multilateral trade resistances when estimating a gravity equation. This can be done by including exporter-time and importer-time fixed effects in a panel or exporter and importer fixed effects in a cross section estimation. I argue that this approach limits the identifiability of policy parameters that capture the effect of certain ”club memberships” (EU, NAFTA, euro area, WTO, etc.) on trade flows. I show that, in the baseline case, only one effect can be identified, which precludes, for example, the estimation of separate effects on the exporter and the importer side. The magnitude, and even the sign, of the estimated club effect are very sensitive to the precise identification assumptions, which are often left unspecified in empirical studies. The underlying problem is that club membership provides some, but very little bilateral variation. When heterogeneous club effects are to be identified, the membership dummies can become perfectly collinear with the fixed effects. Empirical researchers may not be aware of the lack of identification, because standard estimation techniques often permit them to run perfectly collinear regressions. I illustrate the findings with estimating the effect of EU enlargement in 2004 on the trade flows of new and old members. Finally, I discuss potential solutions.

Suggested Citation

  • Cecília Hornok, 2011. "Gravity or Dummies? The Limits of Identification in Gravity Estimations," CeFiG Working Papers 15, Center for Firms in the Global Economy, revised 26 Sep 2011.
  • Handle: RePEc:cfg:cfigwp:15
    as

    Download full text from publisher

    File URL: http://resources.cefig.eu/papers/gravity_or_dummies.pdf
    File Function: May 2012 version (pdf)
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Baldwin, Richard & Taglioni, Daria, 2006. "Gravity for Dummies and Dummies for Gravity Equations," CEPR Discussion Papers 5850, C.E.P.R. Discussion Papers.
    2. Jacks, David S. & Meissner, Christopher M. & Novy, Dennis, 2011. "Trade booms, trade busts, and trade costs," Journal of International Economics, Elsevier, vol. 83(2), pages 185-201, March.
    3. Baier, Scott L. & Bergstrand, Jeffrey H., 2009. "Bonus vetus OLS: A simple method for approximating international trade-cost effects using the gravity equation," Journal of International Economics, Elsevier, vol. 77(1), pages 77-85, February.
    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. Andrew K. Rose, 2004. "Do We Really Know That the WTO Increases Trade?," American Economic Review, American Economic Association, vol. 94(1), pages 98-114, March.
    6. Cecília Hornok, 2011. "Need for Speed: Is Faster Trade in the EU Trade-Creating?," wiiw Working Papers 75, The Vienna Institute for International Economic Studies, wiiw.
    7. Dennis Novy, 2013. "Gravity Redux: Measuring International Trade Costs With Panel Data," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 101-121, January.
    8. 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.
    9. I-Hui Cheng & Howard J. Wall, 2005. "Controlling for heterogeneity in gravity models of trade and integration," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 49-63.
    10. Luca De Benedictis & Roberta De Santis & Claudio Vicarelli, 2005. "Hub-and-Spoke or else? Free trade agreements in the 'enlarged' European Union," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 2(2), pages 245-260, December.
    11. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-623, June.
    12. Eicher, Theo S. & Henn, Christian, 2011. "In search of WTO trade effects: Preferential trade agreements promote trade strongly, but unevenly," Journal of International Economics, Elsevier, vol. 83(2), pages 137-153, March.
    13. Flam, Harry & Nordström, Håkan, 2006. "Euro Effects on the Intensive and Extensive Margins of Trade," Seminar Papers 750, Stockholm University, Institute for International Economic Studies.
    14. Peter Egger & Michael Pfaffermayr, 2003. "The proper panel econometric specification of the gravity equation: A three-way model with bilateral interaction effects," Empirical Economics, Springer, vol. 28(3), pages 571-580, July.
    15. Davis, Peter, 2002. "Estimating multi-way error components models with unbalanced data structures," Journal of Econometrics, Elsevier, vol. 106(1), pages 67-95, January.
    16. Baltagi, Badi H. & Egger, Peter & Pfaffermayr, Michael, 2003. "A generalized design for bilateral trade flow models," Economics Letters, Elsevier, vol. 80(3), pages 391-397, September.
    17. Baldwin, Richard E. & Skudelny, Frauke & Taglioni, Daria, 2005. "Trade effects of the euro: evidence from sectoral data," Working Paper Series 446, European Central Bank.
    18. Shang-Jin Wei, 1996. "Intra-National versus International Trade: How Stubborn are Nations in Global Integration?," NBER Working Papers 5531, National Bureau of Economic Research, Inc.
    19. Cecília Hornok, 2010. "Trade-Enhancing EU Enlargement and the Resurgence of East-East Trade," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 3, pages 79-94.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Erik Marel & Ben Shepherd, 2013. "Services Trade, Regulation and Regional Integration: Evidence from Sectoral Data," The World Economy, Wiley Blackwell, vol. 36(11), pages 1393-1405, November.
    2. Sébastien Miroudot & Ben Shepherd, 2014. "The Paradox of ‘Preferences’: Regional Trade Agreements and Trade Costs in Services," The World Economy, Wiley Blackwell, vol. 37(12), pages 1751-1772, December.
    3. P. Montalbano & S. Nenci, 2014. "Assessing the trade impact of the European Neighbourhood Policy on the EU-MED Free Trade Area," Applied Economics, Taylor & Francis Journals, vol. 46(7), pages 730-740, March.
    4. Thomas Kopp & Sören Prehn & Bernhard Brümmer, 2016. "Preference Erosion – The Case of Everything But Arms and Sugar," The World Economy, Wiley Blackwell, vol. 39(9), pages 1339-1359, September.
    5. Matyas, Laszlo & Balazsi, Laszlo, 2011. "The estimation of three-dimensional fixed effects panel data models," MPRA Paper 34976, University Library of Munich, Germany.
    6. Maria Cipollina & Luca De Benedictis & Luca Salvatici & Claudio Vicarelli, 2016. "Policy Measurement And Multilateral Resistance In Gravity Models," Working Papers LuissLab 16130, Dipartimento di Economia e Finanza, LUISS Guido Carli.
    7. László Mátyás & László Balázsi, 2012. "The Estimation of Multi-dimensional Fixed Effects Panel Data Models," CEU Working Papers 2012_2, Department of Economics, Central European University, revised 18 Feb 2013.
    8. Maria Cipollina & Luca Salvatici & Luca De Benedictis & Claudio Vicarelli, 2013. "A note on dummies for policies in gravity models: a Montecarlo experiment," Departmental Working Papers of Economics - University 'Roma Tre' 0180, Department of Economics - University Roma Tre.
    9. Lavinia Rotili, 2014. "The Euro effects on intermediate and final exports," Working Papers 7/14, Sapienza University of Rome, DISS.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cfg:cfigwp:15. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Miklós Koren). General contact details of provider: http://edirc.repec.org/data/cefighu.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.