The gravity model has been widely used to infer substantial trade flow effects of institutions such as customs unions and exchange rate mechanisms. McCallum [1995] found that the US-Canada border led to trade between provinces that is a factor 22 (2,200%) times trade between states and provinces, a spectacular puzzle in light of the low formal barriers on this border. We show that the gravity model usually estimated does not correspond to the theory behind it. We solve the 'border puzzle' by applying the theory seriously. We find that national borders reduce trade between the US and Canada by about 44%, while reducing trade among other industrialized countries by about 30%. McCallum's spectacular headline number is the result of a combination of omitted variables bias and the small size of the Canadian economy. Within-Canada trade rises by a factor 6 due to the border. In contrast, within-US trade rises 25%.

https://papers.ssrn.com/sol3/Delivery.cfm?abstractid=256086

Gravity with Gravitas: A Solution to the Border Puzzle

The central claim in this paper is that by explicitly introducing costs of international trade (narrowly, transport costs, but more broadly, tariffs, nontariff barriers, and other trade costs), one can go far toward explaining a great number of the main empirical puzzles that international macroeconomists have struggled with over twenty-five years. Our approach elucidates J. McCallum's home-bias-in-trade puzzle, the Feldstein-Horioka saving-investment puzzle, the French-Poterba equity-home-bias puzzle, and the Backus-Kehoe-Kydland consumption-correlations puzzle. That one simple alteration to an otherwise canonical international macroeconomic model can help substantially to explain such a broad range of empirical puzzles, including some that previously seemed intractable, suggests a rich area for future research. We also address a variety of international pricing puzzles, including the purchasing-power-parity puzzle emphasized by Rogoff, and what we term the exchange-rate disconnect puzzle. The latter cat...

/pdf/the-six-major-puzzles-in-international-macroeconomics-is-a9ipbn2dgn.pdf

The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?

Most wars are now civil wars. Even though international wars attract enormous global attention, they have become infrequent and brief. Civil wars usually attract less attention, but they have become increasingly common and typically go on for years. This report argues that civil war is now an important issue for development. War retards development, but conversely, development retards war. This double causation gives rise to virtuous and vicious circles. Where development succeeds, countries become progressively safer from violent conflict, making subsequent development easier. Where development fails, countries are at high risk of becoming caught in a conflict trap in which war wrecks the economy and increases the risk of further war. The global incidence of civil war is high because the international community has done little to avert it. Inertia is rooted in two beliefs: that we can safely 'let them fight it out among themselves' and that 'nothing can be done' because civil war is driven by ancestral ethnic and religious hatreds. The purpose of this report is to challenge these beliefs.

Breaking the Conflict Trap: Civil War and Development Policy

This chapter focuses on the estimation and interpretation of gravity equations for bilateral trade. This necessarily involves a careful consideration of the theoretical underpinnings since it has become clear that naive approaches to estimation lead to biased and frequently misinterpreted results. There are now several theory-consistent estimation methods and we argue against sole reliance on any one method and instead advocate a toolkit approach. One estimator may be preferred for certain types of data or research questions but more often the methods should be used in concert to establish robustness. In recent years, estimation has become just a first step before a deeper analysis of the implications of the results, notably in terms of welfare. We try to facilitate diffusion of best-practice methods by illustrating their application in a step-by-step cookbook mode of exposition.

/pdf/gravity-equations-workhorse-toolkit-and-cookbook-1oadwbzcqo.pdf

Gravity Equations: Workhorse,Toolkit, and Cookbook

I show that undervaluation of the currency (a high real exchange rate) stimulates economic growth. This is true particularly for developing countries. This finding is robust to using different measures of the real exchange rate and different estimation techniques. I also provide some evidence that the operative channel is the size of the tradable sector (especially industry). These results suggest that tradables suffer disproportionately from the government or market failures that keep poor countries from converging toward countries with higher incomes. I present two categories of explanations for why this may be so, the first focusing on institutional weaknesses, and the second on product-market failures. A formal model elucidates the linkages between the real exchange rate and the rate of economic growth.

/pdf/the-real-exchange-rate-and-economic-growth-52ml5nvocw.pdf

The Real Exchange Rate and Economic Growth

Corruption and imperfect contract enforcement dramatically reduce international trade. This paper estimates the reduction using a structural model of import demand in which insecurity acts as a hidden tax on trade. We find that inadequate institutions constrain trade as much as tariffs do. We also find that omission of indices of institutional quality biases the estimates of typical gravity models, obscuring a negative relationship between per capita income and the share of total expenditure devoted to traded goods. Finally, we argue that cross-country variation in the effectiveness of institutions and the consequent variation in the prices of traded goods offer a simple explanation for the stylized fact that high-income, capital-abundant countries trade disproportionately with each other.

/pdf/insecurity-and-the-pattern-of-trade-an-empirical-2fqly7ytaw.pdf

Insecurity and the Pattern of Trade: An Empirical Investigation

Using comparable micro-level data from three countries, we ask what type of person works in the informal sector and whether informal workers earn lower wages than observationally equivalent workers in the formal sector. The characteristics of informal workers are similar across countries. Surprisingly, when we control for these personal characteristics, we find a significant wage premium associated with formal employment in El Salvador and Peru but a premium associated with work in the informal sector in Mexico. A model of endogenous selection offers little help in explaining the differences in wage patterns. The research casts doubt on the received wisdom that the informal sector, always and everywhere, is a poorly-paid but easily- entered refuge for those who have no other employment opportunities.(This abstract was borrowed from another version of this item.)

/pdf/formal-measures-of-the-informal-sector-wage-gap-in-mexico-el-122eq1h751.pdf

Formal Measures of the Informal-Sector Wage Gap in Mexico, El Salvador, and Peru*

The Black Hole of Graft: The Predatory State and the Informal Economy

This article presents a general equilibrium two-country Ricardian trade model with endogenous transactions costs that arise from individual utility-maximizing allocation of labor to production and piracy. In the absence of institutions for risk sharing and coordination of defense, autarky obtains over most of the parameter space. When both trade and predation are supported in equilibrium, terms of trade effects can make security immiserizing. In that case, paradoxically, predation creates trade.

/pdf/anarchy-and-autarky-endogenous-predation-as-a-barrier-to-2x2bpgejd0.pdf

Anarchy and autarky: endogenous predation as a barrier to trade*

Corruption and imperfect contract enforcement dramatically reduce trade. This paper estimates the reduction, using a structural model of import demand in which transactions costs impose a price markup on traded goods. We find that inadequate institutions constrain trade far more than tariffs do. We also find that omitting indexes of institutional quality from the model leads to an underestimate of home bias. Using a broad sample of countries, we find that the traded goods expenditure share declines significantly as income per capita rises, other things equal. Cross-country variation in the effectiveness of institutions offers a simple explanation of the observed global pattern of trade, in which high-income, capital-abundant countries trade disproportionately with one another.

/pdf/trade-insecurity-and-home-bias-an-empirical-investigation-48n7ohxjve.pdf

Douglas Marcouiller

Papers

Insecurity and the Pattern of Trade: An Empirical Investigation

Formal Measures of the Informal-Sector Wage Gap in Mexico, El Salvador, and Peru*

The Black Hole of Graft: The Predatory State and the Informal Economy

Anarchy and autarky: endogenous predation as a barrier to trade*

Trade, Insecurity, and Home Bias: An Empirical Investigation