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Structural Gravity with Dummies Only

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  • Egger, Peter
  • Nigai, Sergey

Abstract

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 consists of a product of exporter-time-specific factors, importer-time-specific factors, and country-pair-time-specific trade costs, and that log trade costs are additively composed of a parameterized part and a residual part. We demonstrate that residual trade costs are relatively important and that the parameters on observable trade-cost measures as well as the structural country-time-specific variables or parameters are inevitably biased no matter of whether models are estimated by ordinary least-squares or by exponential-family models. The reason is that the country-specific variables are endogenous to the 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. All of the proposed remedies involve binary indicator variables (fixed effects) only, and they are nonlinear in both variables and parameters. We therefore dub these approaches as ones of a constrained analysis of variance (CANOVA) of bilateral exports or imports. We propose saturated as well as unsaturated versions of the CANOVA approach for both cross-section and panel data. The saturated approach uses up all degrees of freedom and estimates as many parameters as there are observations on bilateral exports or imports, providing an exact decomposition of bilateral trade into trade costs and country-specific parameters. The unsaturated approaches do not use up all degrees of freedom and estimate fewer parameters than there are observations on bilateral exports or imports, providing an approximate decomposition of bilateral trade into trade costs and country-specific parameters. We demonstrate that with panel data an unsaturated model with exporter-time, importer-time and country-pair effects works quite well relative to both the saturated model as well as models with parameterized trade-cost functions. The conclusions of the CANOVA models regarding the importance of trade costs for trade turn out to be substantially different from the ones implied by the conventional parameterized trade-cost-function models

Suggested Citation

  • Egger, Peter & Nigai, Sergey, 2015. "Structural Gravity with Dummies Only," CEPR Discussion Papers 10427, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10427
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    References listed on IDEAS

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    Cited by:

    1. Hugo Rojas-Romagosa & Eddy Bekkers & Joseph F. Francois, 2015. "Melting Ice Caps and the Economic Impact of Opening the Northern Sea Route," CPB Discussion Paper 307, CPB Netherlands Bureau for Economic Policy Analysis.
    2. Anderson, James E. & Yotov, Yoto V., 2016. "Terms of trade and global efficiency effects of free trade agreements, 1990–2002," Journal of International Economics, Elsevier, pages 279-298.
    3. James E. Anderson & Yoto V. Yotov, 2017. "Short Run Gravity," NBER Working Papers 23458, National Bureau of Economic Research, Inc.
    4. Susanne Fricke & Geoffrey Chapman, 2017. "The Role of Standards in North-South Trade: The Case of Agricultural Exports from Sub-Saharan African Countries to the EU," Jena Economic Research Papers 2017-011, Friedrich-Schiller-University Jena.
    5. Peter Egger & Kevin Staub, 2016. "GLM estimation of trade gravity models with fixed effects," Empirical Economics, Springer, vol. 50(1), pages 137-175, February.
    6. Peter Egger & Jan Průša, 2016. "The determinants of trade costs: a random coefficient approach," Empirical Economics, Springer, vol. 50(1), pages 51-58, February.
    7. Peter Egger & Michael Pfaffermayr, 2016. "A generalized spatial error components model for gravity equations," Empirical Economics, Springer, pages 177-195.
    8. Badi H. Baltagi & Peter Egger, 2016. "Estimation of structural gravity quantile regression models," Empirical Economics, Springer, pages 5-15.
    9. Samuel Standaert & Glenn Rayp, 2015. "Trade Integration And Trade Agreements:Resolving The Endogeneity Problem Through A Qualitative Var," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 15/912, Ghent University, Faculty of Economics and Business Administration.
    10. Scott French, 2017. "A Gravity-Based Revealed Comparative Advantage Estimator," Discussion Papers 2017-05, School of Economics, The University of New South Wales.
    11. Piermartini, Roberta & Yotov, Yoto, 2016. "Estimating Trade Policy Effects with Structural Gravity," School of Economics Working Paper Series 2016-10, LeBow College of Business, Drexel University.
    12. Baier, Scott & Kerr, Amanda & Yotov, Yoto, 2017. "Gravity, Distance, and International Trade," School of Economics Working Paper Series 2017-5, LeBow College of Business, Drexel University.
    13. Egger, Peter Hannes & Nigai, Sergey & Strecker, Nora M., 2016. "The Taxing Deed of Globalization," Annual Conference 2016 (Augsburg): Demographic Change 145953, Verein für Socialpolitik / German Economic Association.

    More about this item

    Keywords

    fixed effects estimation; gravity models; panel econometrics; structural general equilibrium models;

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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