Gravity in Transition

James Anderson and Yoto Yotov

No 2025004, Working Papers from Center for Global Policy Analysis, LeBow College of Business, Drexel University

Abstract: We propose a reduced-form transitional gravity model and an accompanying flexible reduced-form estimation approach. The Lucas-Prescott adjustment model is extended to allow for lag-interval-varying depreciation-cum-adjustment-cost of bilateral trade capacities. The resulting lag-interval-varying trade elasticities vary from 0.4 in the short run to 4.8 in the long run. Long-run equilibrium is reached in about 14-15 years. The model rationalizes trade elasticities that are less than one and offers a potential solution to the ‘international elasticity puzzle’ - the discrepancy between trade elasticities from the trade and macro literatures. Theories of dynamic adjustment in trade costs are supported, and phasing-in effects of FTAs are explained.

Keywords: Short vs. Long Run; Gravity Estimation; Trade Elasticity (search for similar items in EconPapers)
JEL-codes: F13 F14 F16 (search for similar items in EconPapers)
Pages: 40
Date: 2025-01
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