Research Methods Gravity Model Research Methods Objectives Understanding

Research Methods Gravity Model

Research Methods Objectives • Understanding the impact of distance on trade using the gravity model • Assess what the gravity model tells us about competing theories of trade • See how people use the gravity model to evaluate economic policy issues Gravity Model

Research Methods Gravity Model

Research Methods Overall explanatory power • R 2 between 0. 65 and 0. 95 • Suggests using gravity as a benchmark for volume of trade. • Can then use gravity based benchmark to evaluate economic policy Gravity Model

Research Methods The role of economic mass • Usually measured using GDP • Most theoretical explanations predict coefficient equal to one • Estimates often not significantly different from 1, but range is from 0. 7 to 1. 1 Gravity Model

Research Methods The role of distance • Distance usually measured using great circle distance based on latitude and longitude • Head (2000) averages results from 62 regressions in eight papers, for sample years ranging from 1928 to 1995 – Average distance effect is 1. 01 – Doubling distance halves trade Gravity Model

Research Methods Distance and trade costs • Trade costs: – Direct (transport) – Indirect (government policy; language) • Is distance just capturing the effect of trade costs (acting as a proxy) or does it play an additional role? Gravity Model

Research Methods Data on trade costs • IMF bilateral data of total exports from A (free on board) to imports of B (cost-insurancefreight) – Composition of trade depends on t. c. • National customs data for a few countries • Direct industry/shipping company info – Ocean shipping prices/air freight from trade journals (Hummels) – Quotes from shipping standard container from Baltimore (Venables) Gravity Model

Research Methods Magnitude • Wide dispersion of trade costs – US 3. 8% value of imports (1994) – Brazil 7. 3% – Paraguay 13. 3% • Unweighted (get rid of composition effect) – Median cif/fob ratio 1. 28 (28% t. c. ) – 2 to 3 times higher than weighted Gravity Model

Research Methods Gravity Model

Research Methods Effect of distance on t. c. • • Mean cost if not landlocked $4, 620 Landlocked increases cost by $3, 450 Overland 7 times more expensive than sea For cif/fob ratios – Elasticity w. r. t distance 0. 2 to 0. 3 – Common border reduces substantially • R 2 = 0. 45 Gravity Model

Research Methods Distance and gravity • Distance explains around 45% variation in transport costs • Regressions of trade flows on both distance and t. c. still gives significant coefficient on distance (although magnitude lower) • Distance must be a proxy for both t. c. and other information costs. Gravity Model

Research Methods Gravity Model

Research Methods The importance of borders • Canada-Canada province trade approx. 20 times Canada-US state trade – Ontario’s shipments to British Columbia should be 0. 6 times shipments to Washington (US) [Washington is richer] – BC receives 12. 6 times more goods from Ontario than Washington – Border effect = 12. 6/0. 6 = 21 • Fallen to 12 since FTA implemented Gravity Model

Research Methods Conclusions • Distance matters for trade • Consistent with both new trade theory and old trade theory • Theory has helped refine the gravity relationship • Gravity can be used to test other hypotheses even if we don’t know what drives gravity Gravity Model

Research Methods Additional references • Limao and Venables (2002) “Infrastructure, Geographical Disadvantage, Transport Cost and Trade” • http: //econ. lse. ac. uk/staff/ajv/nltv. pdf Gravity Model

Research Methods Assessing Regional Trade Arrangements: Are South-South RTAs More Trade Diverting? Lucian Cernat Gravity Model

Model Research Methods Gravity Model

Research Methods Gravity Model

Research Methods Regional Integration and FDI IDB: The New Regionalism • Gravity Model: the model presumes that bilateral trade FDI flows are related positively to the product of the GDPs of both economies and negatively to the distance between them. Gravity Model

Research Methods Gravity Model