Estimating Border Effects: The Impact of Spatial Aggregation

Trade data are typically reported at the level of regions or countries and are therefore aggregates across space. In this paper, we investigate the sensitivity of standard gravity estimation to spatial aggregation. We build a model in which symmetric micro regions are aggregated into macro regions. We then apply the model to the large literature on border effects in domestic and international trade. Our theory shows that aggregation leads to border effect heterogeneity. Larger regions or countries are systematically associated with smaller border effects. The reason is that due to spatial frictions, aggregation across space increases the cost of trading within borders. The cost of trading across borders therefore appears relatively smaller. We call this mechanism the spatial attenuation effect. Even if no border frictions exist at the micro level, gravity estimation can still produce large border effects. We test our theory with trade flows at the level of U.S. states. Our results confirm the models predictions, with quantitatively strong heterogeneity patterns.