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From Theory to Policy with Gravitas: A Solution to the Mystery of the Excess Trade Balances

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  • Felbermayr , Gabriel

    (Kiel Institute & Kiel University)

  • Yotov, Yoto

    (School of Economics Drexel University LeBow College of Business)

Abstract

Bilateral trade balances often play an important role in the international trade policy debate. Academic economists understand that they are misleading indicators of competitiveness and of the gains from trade. However, they also recognize their political relevance, calling for accurate statistical measurement and for more scholarly work. Disturbingly, Davis and Weinstein (2002) argue that the canonical gravity model of trade fails when confronted with bilateral trade balances data, dubbing this ``The Mystery of the Excess Trade Balances''. Capitalizing on the latest developments in the theoretical and empirical gravity literature, we demonstrate that the workhorse international trade model actually performs well in explaining bilateral trade balances. Moreover, in our data, only 11 to 13% of the variance in bilateral balances is due to asymmetric bilateral trade costs, belying beliefs that bilateral imbalances are driven by `unfair' manipulation of terms-of-trade. We also perform several general equilibrium experiments within the same structural gravity framework to show that free trade agreements tend to exacerbate bilateral imbalances and that macroeconomic rebalancing leads to adjustment with all trade partners.

Suggested Citation

  • Felbermayr , Gabriel & Yotov, Yoto, 2019. "From Theory to Policy with Gravitas: A Solution to the Mystery of the Excess Trade Balances," School of Economics Working Paper Series 2019-5, LeBow College of Business, Drexel University.
  • Handle: RePEc:ris:drxlwp:2019_005
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    References listed on IDEAS

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    1. Natalia Ramondo & Andrés Rodríguez-Clare & Milagro Saborío-Rodríguez, 2016. "Trade, Domestic Frictions, and Scale Effects," American Economic Review, American Economic Association, vol. 106(10), pages 3159-3184, October.
    2. Robert Zymek, 2018. "Bilateral Trade Imbalances," 2018 Meeting Papers 1117, Society for Economic Dynamics.
    3. Beverelli, Cosimo & Keck, Alexander & Larch, Mario & Yotov, Yoto, 2018. "Institutions, Trade and Development: A Quantitative Analysis," School of Economics Working Paper Series 2018-3, LeBow College of Business, Drexel University.
    4. Benedikt Heid & Mario Larch & Yoto V. Yotov, 2021. "Estimating the effects of non‐discriminatory trade policies within structural gravity models," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 54(1), pages 376-409, February.
    5. Yotov, Yoto V., 2012. "A simple solution to the distance puzzle in international trade," Economics Letters, Elsevier, vol. 117(3), pages 794-798.
    6. Ricardo Reyes-Heroles, 2017. "The Role of Trade Costs in the Surge of Trade Imbalances," 2017 Meeting Papers 212, Society for Economic Dynamics.
    7. Dai, Mian & Yotov, Yoto & Zylkin, Thomas, 2013. "On the Trade-diversion Effects of Free Trade Agreements," School of Economics Working Paper Series 2013-3, LeBow College of Business, Drexel University, revised 15 Sep 2014.
    8. Baier, Scott L. & Yotov, Yoto V. & Zylkin, Thomas, 2019. "On the widely differing effects of free trade agreements: Lessons from twenty years of trade integration," Journal of International Economics, Elsevier, vol. 116(C), pages 206-226.
    9. Martin T Braml & Gabriel J Felbermayr, 2019. "What Do We Really Know about the Transatlantic Current Account?," CESifo Economic Studies, CESifo, vol. 65(3), pages 255-274.
    10. Donald R. Davis & David E. Weinstein, 2002. "The Mystery of the Excess Trade (Balances)," American Economic Review, American Economic Association, vol. 92(2), pages 170-174, May.
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    Cited by:

    1. Mario Larch & Jeff Luckstead & Yoto V. Yotov, 2021. "Economic Sanctions and Agricultural Trade," CESifo Working Paper Series 9410, CESifo.
    2. Martin T Braml & Gabriel J Felbermayr, 2019. "What Do We Really Know about the Transatlantic Current Account?," CESifo Economic Studies, CESifo, vol. 65(3), pages 255-274.
    3. Virginia Di Nino & Anna Ekstam, 2020. "What value added in the trade balances of euro area financial centres?," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Bridging measurement challenges and analytical needs of external statistics: evolution or revolution?, volume 52, Bank for International Settlements.
    4. Yilmazkuday, Hakan, 2021. "Accounting for trade deficits," Journal of International Money and Finance, Elsevier, vol. 115(C).
    5. Theresa M. Greaney & Kozo Kiyota, 2020. "Japan’s Outward FDI Potential," Working Papers 202005, University of Hawaii at Manoa, Department of Economics.
    6. Greaney, Theresa M. & Kiyota, Kozo, 2020. "Japan's outward FDI potential," Journal of the Japanese and International Economies, Elsevier, vol. 57(C).

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    More about this item

    Keywords

    Trade Imbalances; Structural Gravity Estimation;

    JEL classification:

    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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