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1 / 24 International Trade Lecture 1: Trade Facts and the Gravity Equation Stefania Garetto
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Page 1: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

1 / 24

International TradeLecture 1: Trade Facts and the Gravity Equation

Stefania Garetto

Page 2: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

The Field of International Trade

Introduction

• Facts

• Theory

Gravity

2 / 24

The field of International Trade tries to answer the following questions:

• What explains the pattern of trade across countries?

• What explains the changes in trade patterns over time?

• Which goods do countries trade?

• Which kind of firms trade?

• What can explain the growth in trade? Does trade affect GDP growth?

• What are the effects of trade on the labor markets?

• What is the role of outsourcing, foreign direct investment (FDI) andmultinational production (MP)? How do they affect trade patterns?

Page 3: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

World Trade

3 / 24

• After WWII, unprecedented growth of trade volumes, both in absolute terms and as% of GDP.

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World Trade

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World Trade

(% of World GDP)

Export Import

Figure 1: Volumes of World Trade

Page 4: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

U.S. Trade

4 / 24

• In the last 50 years, volumes of trade in the U.S. increased ten-fold.• In recent years, negative trade balance.

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US Trade (billions of constant 2010 US$)

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US Trade (% of US GDP)

Imports Exports

Figure 2: Volumes of US Trade

Page 5: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Trading Countries

Introduction

• Facts

• Theory

Gravity

5 / 24

• Major exporters (in absolute value): China, United States, Germany.

• Trade within U.S. + Europe accounts for about 1/3 of world total trade.

• Exports from U.S. + Europe account for about 50% of world total export.

Europe and the Americas 58%Asia 28%Middle East and Russia 10%Africa 2.5%Australia and New Zealand 1.5%

Table 1: Share of world export, by area (2000).

• More than 50% of total trade flows happen between developedcountries, about 15% between developing countries, about 30%between developed and developing countries.

• Rising importance of China: Chinese exports increased 30-fold from1978 to 2008 (from 2 to 40% of GDP).

Page 6: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Trading Countries (cont.)

Introduction

• Facts

• Theory

Gravity

6 / 24

Figure 3: Trade as a % of GDP, selected countries.

Page 7: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

U.S. Trading Partners

Introduction

• Facts

• Theory

Gravity

7 / 24

Large volumes of trade with neighboring countries and large countries .

Page 8: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Helpman JEP 1999: what happened in the field 1960-1990

Introduction

• Facts

• Theory

Gravity

8 / 24

Well, even before that...

• 1817: Ricardo’s Principles of Political Economy and Taxation

THEORY OF COMPARATIVE ADVANTAGE: a country exports productsin which its labor productivity is high relative to its labor productivity inother products, compared to the same magnitude for its tradingpartner(s).

• 1920s: Heckscher-Ohlin (HO)

FACTOR ENDOWMENTS DETERMINE THE PATTERN OF TRADE: acountry should export the product that is relatively intensive in using thefactor with which the country is relatively well-endowed.

The intuitive content of the HO Theory made it the dominant framework inthe early stages of the field...

Page 9: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Testing the Heckscher-Ohlin prediction

Introduction

• Facts

• Theory

Gravity

9 / 24

... attracting the attention of empirical research too:

• 1954: LEONTIEF PARADOX:

Leontief found that the K/L ratio embodied in US imports exceededthe one in US exports (opposite to HO if we believe the US are morecapital intensive than their trading partners).

Page 10: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Testing the Heckscher-Ohlin prediction

Introduction

• Facts

• Theory

Gravity

9 / 24

... attracting the attention of empirical research too:

• 1954: LEONTIEF PARADOX:

Leontief found that the K/L ratio embodied in US imports exceededthe one in US exports (opposite to HO if we believe the US are morecapital intensive than their trading partners).

• 1960s-1980s: other attempts to test the theory obtained mixed results.

BUT: based on pure accounting relationships and unrealisticassumptions: factor price equalization (FPE), common technologiesand production structures across countries.

Page 11: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Testing the Heckscher-Ohlin prediction

Introduction

• Facts

• Theory

Gravity

9 / 24

... attracting the attention of empirical research too:

• 1954: LEONTIEF PARADOX:

Leontief found that the K/L ratio embodied in US imports exceededthe one in US exports (opposite to HO if we believe the US are morecapital intensive than their trading partners).

• 1960s-1980s: other attempts to test the theory obtained mixed results.

BUT: based on pure accounting relationships and unrealisticassumptions: factor price equalization (FPE), common technologiesand production structures across countries.

• Trefler (1995): attempt of taking into account productivity differences.

BUT: one can always reconcile the theory with the data adding arbitrarydifferences in technologies/production structure across countries andsectors, but this is not progress.

Page 12: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Testing the Heckscher-Ohlin prediction

Introduction

• Facts

• Theory

Gravity

9 / 24

... attracting the attention of empirical research too:

• 1954: LEONTIEF PARADOX:

Leontief found that the K/L ratio embodied in US imports exceededthe one in US exports (opposite to HO if we believe the US are morecapital intensive than their trading partners).

• 1960s-1980s: other attempts to test the theory obtained mixed results.

BUT: based on pure accounting relationships and unrealisticassumptions: factor price equalization (FPE), common technologiesand production structures across countries.

• Trefler (1995): attempt of taking into account productivity differences.

BUT: one can always reconcile the theory with the data adding arbitrarydifferences in technologies/production structure across countries andsectors, but this is not progress.

Page 13: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Back to Ricardo?

Introduction

• Facts

• Theory

Gravity

10 / 24

• The empirical failure of the HO model motivated a “return” of the field toRicardian frameworks: the data suggest the need to MODELCROSS-COUNTRY DIFFERENCES IN TECHNOLOGY ANDPRODUCTION STRUCTURE.

• Only in the early 2000s the Ricardian model comes back as the“textbook” framework that provides a good fit with the (aggregate) tradedata (Eaton and Kortum, 2002).

In the meantime...

Page 14: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

The “New Trade Theory”

Introduction

• Facts

• Theory

Gravity

11 / 24

• Krugman (1979): new, complementary theory based on ECONOMIESOF SCALE and PRODUCT DIFFERENTIATION.

Motivated by:

1. Large volumes of trade between countries with similar factorproportions.

2. Large volumes of intra-industry trade.

(None of this can be driven by differences in factor endowments).

Page 15: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

The “New Trade Theory”

Introduction

• Facts

• Theory

Gravity

11 / 24

• Krugman (1979): new, complementary theory based on ECONOMIESOF SCALE and PRODUCT DIFFERENTIATION.

Motivated by:

1. Large volumes of trade between countries with similar factorproportions.

2. Large volumes of intra-industry trade.

(None of this can be driven by differences in factor endowments).

Economies of scale favor countries’ specialization in different products andcould explain different countries’ development and use of differenttechnologies and production structures.

Consumers’ “taste for variety” then leads to intra-industry trade.

Page 16: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

The “New Trade Theory”

Introduction

• Facts

• Theory

Gravity

11 / 24

• Krugman (1979): new, complementary theory based on ECONOMIESOF SCALE and PRODUCT DIFFERENTIATION.

Motivated by:

1. Large volumes of trade between countries with similar factorproportions.

2. Large volumes of intra-industry trade.

(None of this can be driven by differences in factor endowments).

Economies of scale favor countries’ specialization in different products andcould explain different countries’ development and use of differenttechnologies and production structures.

Consumers’ “taste for variety” then leads to intra-industry trade.

[The first part of this semester will be devoted to cover the H-O model,Ricardian Trade Theory, and New Trade Theory].

Page 17: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Back to the Data: Trade and Size

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

12 / 24

Page 18: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Trade and Distance

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

13 / 24

Page 19: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Trade, Size, and Distance: the Gravity Equation

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

14 / 24

• The data suggest that bilateral trade flows are increasing in the size(GDP) of the countries involved, and decreasing in the distancebetween them.

Page 20: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Trade, Size, and Distance: the Gravity Equation

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

14 / 24

• The data suggest that bilateral trade flows are increasing in the size(GDP) of the countries involved, and decreasing in the distancebetween them.

• This pattern can be tested empirically with the Gravity Equation :

Tij = α+ β(GDPi ×GDPj) + γDij + εij

where:

◦ Tij denotes bilateral trade flows between countries i and j◦ Dij denotes distance between countries i and j.

Page 21: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Trade, Size, and Distance: the Gravity Equation

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

14 / 24

• The data suggest that bilateral trade flows are increasing in the size(GDP) of the countries involved, and decreasing in the distancebetween them.

• This pattern can be tested empirically with the Gravity Equation :

Tij = α+ β(GDPi ×GDPj) + γDij + εij

where:

◦ Tij denotes bilateral trade flows between countries i and j◦ Dij denotes distance between countries i and j.

• There is “gravity” when:

◦ β > 0◦ γ < 0.

Page 22: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Deriving the Gravity Equation

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

15 / 24

Consider a world where:- every country is specialized in a distinct set of products;- each country’s population has the same homothetic preferences;- trade is balanced;- trade costs are positively related to the distance between the countriesinvolved.

Page 23: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Deriving the Gravity Equation

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

15 / 24

Consider a world where:- every country is specialized in a distinct set of products;- each country’s population has the same homothetic preferences;- trade is balanced;- trade costs are positively related to the distance between the countriesinvolved.

⇓- expenditures in each good are proportional to GDP levels ⇒expenditures in imported goods are also proportional to GDP levels.- expenditures in foreign goods are lower the higher the distance betweentrading partners.

Page 24: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Deriving the Gravity Equation

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

15 / 24

Consider a world where:- every country is specialized in a distinct set of products;- each country’s population has the same homothetic preferences;- trade is balanced;- trade costs are positively related to the distance between the countriesinvolved.

⇓- expenditures in each good are proportional to GDP levels ⇒expenditures in imported goods are also proportional to GDP levels.- expenditures in foreign goods are lower the higher the distance betweentrading partners.

GRAVITY: VOLUMES OF TRADE are positively related to the GDPLEVELS of the trading countries and negatively related to the DISTANCEbetween the trading countries.

[Notice: gravity needs a minimal set of assumptions to hold. It could begenerated by a Ricardian model, by HO, or by the new trade theorymodels.]

Page 25: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

The Gravity Equation under Free Trade

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

16 / 24

- yik : country i’s output of good k;

- Y i :=

N∑

k=1

yik : country i’s GDP;

- Y :=

I∑

i=1

Y i : world GDP;

- si := Y i/Y : country i’s share of world expenditure (GDP).

Exports from i to j of good k: Xijk = sjyik.

Total exports from i to j:

Xij =

N∑

k=1

Xijk = sj

N∑

k=1

yik = sjY i =Y jY i

Y= sjsiY (= Xji).

Bilateral trade between i and j:

Xij +Xji =2Y jY i

Y= 2sjsiY. (1)

Page 26: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

The Role of Trade Barriers: The Border Effect

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

17 / 24

McCallum (1995): compare within-Canada and US-Canada trade.

lnXij = α+ β1ln(Yi) + β2ln(Y

j) + ρln(dij) + γδij + εij

where dij= distance and δij = 1 if within-Canada trade, zero otherwise.

Results:

β1, β2 ≈ 1ρ < 0 ⇒ negative effect of distanceγ ≈ 3 ⇒ BORDER EFFECT: intranational trade is

about 22 times larger than international trade!!!

⇒ Need of introducing TRADE BARRIERS into the analysis!

BUT: This implies that prices may differ across countries: need for moremicrofoundation, including prices in the Gravity equation.

Page 27: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

A Simple Model

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

18 / 24

- Xij

k: exports from i to j of good k ;

- cijk

: consumption in j of good k (produced in i), Xij

k= p

ij

kcij

k;

- N i : number of products produced in country i;- pi : F.O.B. price of goods produced in country i;- pij = T ijpi : C.I.F. price of goods prod. in i and sold in j, T ij ≥ 1, T ii

= 1.

Assume each good is produced with the same technology:pijk = pij , ∀k ⇒ cijk = cij , ∀k.

Consumers’problem:

maxcij

U j =

[

I∑

i=1

N i(cij)σ−1

σ

]

σσ−1

s.t.I

i=1

N ipijcij = Y j

(where σ > 1). The solution takes the form:

Xij = N i

(

pij

P j

)1−σ

Y j =Y iY j

(pi)σy

(

T ij

P j

)1−σ

(2)

where P j =[

∑I

i=1N i(pij)1−σ

]1

1−σ

and y = Y i/(N ipi).

Page 28: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Estimating Price Indexes

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

19 / 24

Gravity Equation:

Xij =Y iY j

(pi)σy

(

T ij

P j

)1−σ

Estimating equation:

∆lnXij = ∆ln(Y iY j)+(1−σ)∆lnT ij−σ∆lnpi+(σ−1)∆ln(P j)+εij

Page 29: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Estimating Price Indexes

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

19 / 24

Gravity Equation:

Xij =Y iY j

(pi)σy

(

T ij

P j

)1−σ

Estimating equation:

∆lnXij = ∆ln(Y iY j)+(1−σ)∆lnT ij−σ∆lnpi+(σ−1)∆ln(P j)+εij

But ideal price indexes are not observable! 3 approaches:

1. directly measure them as GDP deflators ;

2. estimate them using the market clearing conditions of the model:Anderson and van Wincoop (2003);

3. proxy for them using country fixed effects .

Page 30: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

20 / 24

Market clearing: piyi =

I∑

j=1

T ijpicij .

Theorem 1 Assume trade costs are symmetric: T ij = T ji. Then animplicit solution to the market clearing condition is:

pi =1

P i

(

si

N i

)

1

1−σ

(3)

which implies:

(P j)1−σ =I

i=1

si(

T ij

P i

)1−σ

. (4)

Why this is progress? Substituting (3) into the gravity equation, we obtain:

Xij =Y iY j

Y

(

T ij

P iP j

)1−σ

.

Page 31: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003) (cont.)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

21 / 24

Assume the following form for T ij :

T ij = τ ij + ρln(dij) + εij . (5)

The gravity equation Xij = Y iY j

Y

(

T ij

P iP j

)1−σ

leads to the following

estimation equation:

ln(Xij/(Y iY j)) = ρ(1− σ)ln(dij) + (1− σ)τ ij + ...

+ln(P i)σ−1 + ln(P j)σ−1 + (1− σ)εij . (6)

Estimation of system (4)-(6):

1. Run the estimation equation (6).2. Use (5) to obtain predicted values for T ij .3. Use (4) to compute the “multilateral resistance terms” (P i)σ−1,

(P j)σ−1).4. Iterate until convergence.

Page 32: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003) (cont.)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

22 / 24

Results:

1. Size (+) and trade barriers (-) matter in determining volumes of trade.

Page 33: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003) (cont.)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

22 / 24

Results:

1. Size (+) and trade barriers (-) matter in determining volumes of trade.

2. The multilateral resistance terms P j describe how “remote” a countyis from the rest of the world: for given trade barriers, the more isolated acountry is, the higher the price index, the lower is the volume of trade.

Page 34: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003) (cont.)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

22 / 24

Results:

1. Size (+) and trade barriers (-) matter in determining volumes of trade.

2. The multilateral resistance terms P j describe how “remote” a countyis from the rest of the world: for given trade barriers, the more isolated acountry is, the higher the price index, the lower is the volume of trade.

3. Estimates of τ ij (the border effect on prices ) depend on the value ofσ and range between 10-50% ;

Page 35: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003) (cont.)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

22 / 24

Results:

1. Size (+) and trade barriers (-) matter in determining volumes of trade.

2. The multilateral resistance terms P j describe how “remote” a countyis from the rest of the world: for given trade barriers, the more isolated acountry is, the higher the price index, the lower is the volume of trade.

3. Estimates of τ ij (the border effect on prices ) depend on the value ofσ and range between 10-50% ;

4. Downsizing of McCallum estimates of the border effect for Canada:intranational trade is about 10 times higher than international trade forCanada ⇒ McCallum larger number is due to the omitted variablesP i.

Page 36: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2003) (cont.)

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

22 / 24

Results:

1. Size (+) and trade barriers (-) matter in determining volumes of trade.

2. The multilateral resistance terms P j describe how “remote” a countyis from the rest of the world: for given trade barriers, the more isolated acountry is, the higher the price index, the lower is the volume of trade.

3. Estimates of τ ij (the border effect on prices ) depend on the value ofσ and range between 10-50% ;

4. Downsizing of McCallum estimates of the border effect for Canada:intranational trade is about 10 times higher than international trade forCanada ⇒ McCallum larger number is due to the omitted variablesP i.

5. Asymmetry of the border effect : intranational trade is about 2.5 timeshigher than international trade for the US, suggesting a larger bordereffect for smaller countries.

Page 37: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Anderson and van Wincoop (2004) : “Trade Costs”

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

23 / 24

Exhaustive survey of the literature on measurement of trade costs.Look at different types of trade costs:

1. Transportation costs2. Policy barriers (tariff and non-tariff barriers)3. Wholesale and distribution costs

and at sources of data on trade costs:

• direct measures• indirect measures

◦ from evidence on quantities◦ from evidence on prices.

Use gravity theory to infer trade costs from trade volumes and otherobservable variables.

Page 38: International Trade Lecture 1: Trade Facts and the Gravity ...people.bu.edu/garettos/teaching_docs/Class1.pdf · International Trade Lecture 1: Trade Facts and the Gravity Equation

Disdier and Head (2008) : “The Puzzling Persistence of theDistance Effect on Bilateral Trade”

Introduction

Gravity

• Evidence

• Setup

• Border Effect

• Trade Costs

• Distance

24 / 24

Meta-analysis of the relation between distance and bilateral trade flows(look at 1,467 gravity estimates in 103 papers).

Main results:

• Persistence of the distance effect:

1. Significant effect in all studies (with different samples andmethodologies);

2. NOT declining over time: the negative impact of distance on tradeflows increased around 1950 and remained persistently high sincethen.

• Mean estimated distance effect: -0.9 (a 10% increase in distancelowers bilateral trade by about 9% ). This is a large effect, cannot ariseonly because of transportation costs!


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