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The Gravity Equation in International Trade: An Explanation

  • Chaney, Thomas

The gravity equation in international trade is one of the most robust empirical finding in economics: bilateral trade between two countries is proportional to size, measured by GDP, and inversely proportional to the geographic distance between them. While the role of size is well understood, the role of distance remains a mystery. I propose the first explanation for the gravity equation in international trade, based on the emergence of a stable network of input-output linkages between firms. Over time, a firm acquires more suppliers and customers, which tend to be further away. I show that if, as observed empirically, (i) the distribution of firm sizes is well approximated by Zipf’s law and (ii) larger firms export over longer distances on average, then aggregate trade is inversely proportional to distance. Data on firm level, sectoral, and aggregate trade support further predictions of the model.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9613.

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Date of creation: Aug 2013
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Handle: RePEc:cpr:ceprdp:9613
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  1. Daron Acemoglu & Vasco Carvalho & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2011. "The network origins of aggregate fluctuations," Economics Working Papers 1291, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Xavier Gabaix & Rustam Ibragimov, 2011. "Rank - 1 / 2: A Simple Way to Improve the OLS Estimation of Tail Exponents," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 29(1), pages 24-39, January.
  3. Xavier Gabaix, 1999. "Zipf'S Law For Cities: An Explanation," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 739-767, August.
  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. Thomas Chaney, 2008. "Distorted Gravity: The Intensive and Extensive Margins of International Trade," American Economic Review, American Economic Association, vol. 98(4), pages 1707-21, September.
  6. Thierry Mayer & Soledad Zignago, 2011. "Notes on CEPII’s distances measures: The GeoDist database," Working Papers 2011-25, CEPII research center.
  7. di Giovanni, Julian & Levchenko, Andrei A., 2013. "Firm entry, trade, and welfare in Zipf's world," Journal of International Economics, Elsevier, vol. 89(2), pages 283-296.
  8. Robert C. Feenstra & Robert E. Lipsey & Haiyan Deng & Alyson C. Ma & Hengyong Mo, 2005. "World Trade Flows: 1962-2000," NBER Working Papers 11040, National Bureau of Economic Research, Inc.
  9. 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.
  10. Elhanan Helpman & Marc Melitz & Yona Rubinstein, 2008. "Estimating Trade Flows: Trading Partners and Trading Volumes," The Quarterly Journal of Economics, MIT Press, vol. 123(2), pages 441-487, 05.
  11. Elhanan Helpman & Marc J. Melitz & Stephen R. Yeaple, 2004. "Export Versus FDI with Heterogeneous Firms," American Economic Review, American Economic Association, vol. 94(1), pages 300-316, March.
  12. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-16, March.
  13. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, vol. 75, pages 321.
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