Structural gravity with dummies only: Constrained ANOVA-type estimation of gravity models

Peter Egger and Sergey Nigai

Journal of International Economics, 2015, vol. 97, issue 1, 86-99

Abstract: The measurement of trade costs and their effects on outcome is at the heart of a large quantitative literature in international economics. The majority of the recent significant contributions on the matter assumes that trade is log-linear in exporter-specific factors, importer-specific factors, and log trade costs that are additively composed of a parameterized part and a residual part. We demonstrate that, under standard assumptions in the literature, the magnitude of unobservable, residual trade costs is large, and that their ignorance leads to a bias of the importance of observable trade-cost measures as well as of country-specific variables that are either solved implicitly through structural estimation or estimated explicitly as fixed effects. The reason is that, due to general-equilibrium linkages, some country-specific variables are endogenous to residual trade costs, regardless of whether they are captured by iteratively-solved structural terms or by country(-time) fixed effects. As a result, quantifications of effects of trade costs and comparative static results are also biased. Apart from diagnosing this problem, the paper provides remedies for it by proposing theory-consistent approaches including a two-step procedure that permits identifying partial effects of observable gravity variables on total trade costs and trade flows which do not suffer from the unobserved-trade-cost bias.

Keywords: Gravity models; Structural general-equilibrium models; Fixed effects estimation (search for similar items in EconPapers)
JEL-codes: C23 F14 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (117)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:97:y:2015:i:1:p:86-99

DOI: 10.1016/j.jinteco.2015.05.004

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