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Structural Estimation of a Flexible Translog Gravity Model

How large are the gains from trade? Do all trade models have the ‘same old gains’? Arkolakis, Costinot, and Rodriguez-Clare (2012) show that many quantitative trade models that summarize trade responses via a single elasticity have the same welfare implications. I develop a flexible approach to estimating trade responses using a translog expenditure function, and find welfare results that differ starkly from conventional trade models. In my model, trade responses can vary bilaterally, and the link between own- and cross-price elasticities of trade to trade cost is broken. I apply my approach to inter-regional trade flows in North America and international trade flows between OECD and BRICS countries. I structurally estimate the parameters and conduct counterfactual analyses. Canada’s border effect is at least three times smaller than estimates in previous literature. Compared to those implied by the formula in Arkolakis et al., welfare responses are larger and more heterogeneous. The welfare losses from raising trade barriers are underestimated by eight times for China, France, India, and the United Kingdom, and underestimated by more than ten times for Australia, Brazil, Canada, and Russia.

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Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 1164.

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Length: 44 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:mlb:wpaper:1164
Contact details of provider: Postal: Department of Economics, The University of Melbourne, 4th Floor, FBE Building, Level 4, 111 Barry Street. Victoria, 3010, Australia
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Web page: http://www.economics.unimelb.edu.au
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  1. Jon Haveman & David Hummels, 2004. "Alternative hypotheses and the volume of trade: the gravity equation and the extent of specialization," Canadian Journal of Economics, Canadian Economics Association, vol. 37(1), pages 199-218, February.
  2. Edward Balistreri & Russell Hillberry, 2006. "Trade frictions and welfare in the gravity model: how much of the iceberg melts?," Canadian Journal of Economics, Canadian Economics Association, vol. 39(1), pages 247-265, February.
  3. Alan V. Deardorff, 1995. "Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical World?," NBER Working Papers 5377, National Bureau of Economic Research, Inc.
  4. Anderson, James E, 1979. "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-16, March.
  5. Mark J. Melitz, 2002. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," NBER Working Papers 8881, National Bureau of Economic Research, Inc.
  6. Russell H. Hillberry & Edward J. Balistreri & Thomas F. Rutherford, 2007. "Structural Estimation and Solution of International Trade Models with Heterogeneous Firms," DEGIT Conference Papers c012_038, DEGIT, Dynamics, Economic Growth, and International Trade.
  7. Chris Edmond & Virgiliu Midrigan & Daniel Yi Xu, 2012. "Competition, Markups, and the Gains from International Trade," NBER Working Papers 18041, National Bureau of Economic Research, Inc.
  8. R. Dornbusch & S. Fischer & P. A. Samuelson, 1976. "Comparative Advantage, Trade and Payments in a Ricardian Model With a Continuum of Goods," Working papers 178, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Bergstrand, Jeffrey H, 1985. "The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 474-81, August.
  10. Diewert, W. E. & Wales, T. J., 1988. "A normalized quadratic semiflexible functional form," Journal of Econometrics, Elsevier, vol. 37(3), pages 327-342, March.
  11. 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.
  12. Feenstra, Robert C., 2003. "A homothetic utility function for monopolistic competition models, without constant price elasticity," Economics Letters, Elsevier, vol. 78(1), pages 79-86, January.
  13. Ulrich Kohli, 1994. "Canadian Imports and Exports by Origin and Destination: A Semi-flexible Approach," Canadian Journal of Economics, Canadian Economics Association, vol. 27(3), pages 580-603, August.
  14. Ryan, David L. & Wales, Terence J., 2000. "Imposing local concavity in the translog and generalized Leontief cost functions," Economics Letters, Elsevier, vol. 67(3), pages 253-260, June.
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