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Controlling for heterogeneity in gravity models of trade and integration

  • I-Hui Cheng
  • Howard J. Wall

This paper compares various specifications of the gravity model of trade as nested versions of a general specification that uses bilateral country-pair fixed effects to control for heterogeneity. For each specification, we show that the a theoretical restrictions to obtain them from the general model are not supported statistically. Because the gravity model has become the ‘workhorse’ baseline model for estimating the effects of international integration, this has important empirical implications. In particular, we show that, unless heterogeneity is accounted for correctly, gravity models can greatly overestimate the effects of integration on the volume of trade.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1999-010.

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Date of creation: 2004
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Publication status: Published in Federal Reserve Bank of St. Louis Review, January/February 2005, 87(1), pp. 49-64
Handle: RePEc:fip:fedlwp:1999-010
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  1. Howard J. Wall, 2000. "Gravity model specification and the effects of the Canada-U.S. border," Working Papers 2000-024, Federal Reserve Bank of St. Louis.
  2. Michael R. Pakko & Howard J. Wall, 2001. "Reconsidering the trade-creating effects of a currency union," Review, Federal Reserve Bank of St. Louis, issue May, pages 37-46.
  3. Shang-Jin Wei & Jeffrey A. Frankel, 1997. "Open versus Closed Trade Blocs," NBER Chapters, in: Regionalism versus Multilateral Trade Arrangements, NBER-EASE Volume 6, pages 119-140 National Bureau of Economic Research, Inc.
  4. Peter Egger, 2002. "An Econometric View on the Estimation of Gravity Models and the Calculation of Trade Potentials," The World Economy, Wiley Blackwell, vol. 25(2), pages 297-312, 02.
  5. Jeffrey A. Frankel, 1997. "Regional Trading Blocs in the World Economic System," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 72, May.
  6. Jeffrey A. Frankel & Shang-Jin Wei, 1998. "Regionalization of World Trade and Currencies: Economics and Politics," NBER Chapters, in: The Regionalization of the World Economy, pages 189-226 National Bureau of Economic Research, Inc.
  7. Andrew K. Rose, 2000. "One money, one market: the effect of common currencies on trade," Economic Policy, CEPR;CES;MSH, vol. 15(30), pages 7-46, 04.
  8. John F. Helliwell, 1996. "Do National Borders Matter for Quebec's Trade?," Canadian Journal of Economics, Canadian Economics Association, vol. 29(3), pages 507-22, August.
  9. Cletus C. Coughlin & Howard J. Wall, 2002. "NAFTA and the changing pattern of state exports," Working Papers 2000-029, Federal Reserve Bank of St. Louis.
  10. Howard J. Wall, 2002. "NAFTA and the geography of North American trade," Working Papers 2000-017, Federal Reserve Bank of St. Louis.
  11. Bikker, Jacob A, 1987. "An International Trade Flow Model with Substitution: An Extension of the Gravity Model," Kyklos, Wiley Blackwell, vol. 40(3), pages 315-37.
  12. Wall, Howard-J, 2002. "Has Japan Been Left Out in the Cold by Regional Integration?," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 20(2), pages 117-134, April.
  13. repec:kap:jeczfn:v:82:y:2003:i:4:p:427-450 is not listed on IDEAS
  14. Howard J. Wall, 1999. "Using the gravity model to estimate the costs of protection," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 33-40.
  15. Bayoumi, Tamim & Eichengreen, Barry, 1995. "Is Regionalism Simply a Diversion? Evidence from the Evolution of the EC and EFTA," CEPR Discussion Papers 1294, C.E.P.R. Discussion Papers.
  16. Brada, Josef C & Mendez, Jose A, 1983. "Regional Economic Integration and the Volume of Intra-Regional Trade: A Comparison of Developed and Developing Country Experience," Kyklos, Wiley Blackwell, vol. 36(4), pages 589-603.
  17. Barry Eichengreen & Douglas A. Irwin, 1996. "The Role of History in Bilateral Trade Flows," NBER Working Papers 5565, National Bureau of Economic Research, Inc.
  18. Bergstrand, Jeffrey H, 1989. "The Generalized Gravity Equation, Monopolistic Competition, and the Factor-Proportions Theory in International Trade," The Review of Economics and Statistics, MIT Press, vol. 71(1), pages 143-53, February.
  19. Soloaga, Isidro & Winters, L. Alan, 1999. "Regionalism in the Nineties: What Effect on Trade?," CEPR Discussion Papers 2183, C.E.P.R. Discussion Papers.
  20. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-23, June.
  21. Frankel, Jeffrey & Stein, Ernesto & Wei, Shang-jin, 1995. "Trading blocs and the Americas: The natural, the unnatural, and the super-natural," Journal of Development Economics, Elsevier, vol. 47(1), pages 61-95, June.
  22. Jeffrey A. Frankel & Ernesto Stein & Shang-Jin Wei, 1993. "Continental Trading Blocs: Are They Natural, or Super-Natural?," NBER Working Papers 4588, National Bureau of Economic Research, Inc.
  23. Aitken, Norman D, 1973. "The Effect of the EEC and EFTA on European Trade: A Temporal Cross-Section Analysis," American Economic Review, American Economic Association, vol. 63(5), pages 881-92, December.
  24. Boisso, Dale & Ferrantino, Michael, 1997. "Economic Distance, Cultural Distance, and Openness in International Trade : Empirical Puzzles," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 12, pages 456-484.
  25. Takatoshi Ito & Anne O. Krueger, 1997. "Regionalism versus Multilateral Trade Arrangements, NBER-EASE Volume 6," NBER Books, National Bureau of Economic Research, Inc, number ito_97-1, November.
  26. Laszlo Matyas, 1997. "Proper Econometric Specification of the Gravity Model," The World Economy, Wiley Blackwell, vol. 20(3), pages 363-368, 05.
  27. Sanso, Marcos & Cuairan, Rogelio & Sanz, Fernando, 1993. "Bilateral Trade Flows, the Gravity Equation, and Functional Form," The Review of Economics and Statistics, MIT Press, vol. 75(2), pages 266-75, May.
  28. Smith, Pamela J., 1999. "Are weak patent rights a barrier to U.S. exports?," Journal of International Economics, Elsevier, vol. 48(1), pages 151-177, June.
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