Insecurity and the Pattern of Trade: An Empirical Investigation
01 May 2002-The Review of Economics and Statistics (MIT Press 238 Main St., Suite 500, Cambridge, MA 02142-1046 USA journals-info@mit.edu)-Vol. 84, Iss: 2, pp 342-352
TL;DR: In this article, a structural model of import demand in which insecurity acts as a hidden tax on trade is proposed, and the authors find that inadequate institutions constrain trade as much as tariffs do.
Abstract: 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.
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TL;DR: This article showed that the gravity model usually estimated does not correspond to the theory behind it and showed that national borders reduce trade between the US and Canada by about 44% while reducing trade among other industrialized countries by about 30%.
Abstract: 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%.
6,043Â citations
TL;DR: In this article, the estimation and interpretation of gravity equations for bilateral trade is discussed, and several theory-consistent estimation methods are presented. But the authors argue against sole reliance on any one method and instead advocate a toolkit approach.
Abstract: 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.
1,852Â citations
Cites background from "Insecurity and the Pattern of Trade..."
...Martin et al. (2008) and Anderson and Marcouiller (2002) use the United States as the reference country....
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01 Jan 2009
TL;DR: In this article, the authors show that undervaluation of the currency (a high real exchange rate) stimulates economic growth, particularly for developing countries, and they present two categories of explanations for why this may be so, the first focusing on institutional weaknesses, and the second on product market failures.
Abstract: 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.
1,453Â citations
TL;DR: This paper used data on bilateral trust between European countries and found that lower bilateral trust leads to less trade between two countries, less portfolio investment, and less direct investment, even after controlling for the characteristics of the two countries.
Abstract: How much do cultural biases affect economic exchange? We answer this question by using data on bilateral trust between European countries. We document that this trust is affected not only by the characteristics of the country being trusted, but also by cultural aspects of the match between trusting country and trusted country, such as their history of conflicts and their religious, genetic, and somatic similarities. We then find that lower bilateral trust leads to less trade between two countries, less portfolio investment, and less direct investment, even after controlling for the characteristics of the two countries. This effect is stronger for goods that are more trust intensive. Our results suggest that perceptions rooted in culture are important (and generally omitted) determinants of economic exchange.
1,313Â citations
TL;DR: In this article, the role of transnational networks in alleviating problems of contract enforcement and providing information about trading opportunities is surveyed, and how domestic networks influence international trade through their impact on domestic market structure.
Abstract: The first two main sections survey the roles of transnational networks in alleviating problems of contract enforcement and providing information about trading opportunities, respectively. The next section covers how domestic networks influence international trade through their impact on domestic market structure. Two overarching questions unify these sections: how do networks affect efficiency, and will networks grow or shrink in importance for international trade over time. The last main sections develop research agendas for two less studied areas: the role of intermediaries who can connect foreign agents to domestic networks and the ability of transnational production networks to facilitate technology transfer.
1,197Â citations
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TL;DR: This article showed that the gravity model usually estimated does not correspond to the theory behind it and showed that national borders reduce trade between the US and Canada by about 44% while reducing trade among other industrialized countries by about 30%.
Abstract: 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%.
6,043Â citations
TL;DR: In this article, a method that consistently and efficiently estimates a theoretical gravity equation and correctly calculates the comparative statics of trade frictions was developed to solve the famous McCallum border puzzle.
Abstract: Gravity equations have been widely used to infer trade flow effects of various institutional arrangements. We show that estimated gravity equations do not have a theoretical foundation. This implies both that estimation suffers from omitted variables bias and that comparative statics analysis is unfounded. We develop a method that (i) consistently and efficiently estimates a theoretical gravity equation and (ii) correctly calculates the comparative statics of trade frictions. We apply the method to solve the famous McCallum border puzzle. Applying our method, we find that national borders reduce trade between industrialized countries by moderate amounts of 20-50 percent.
4,997Â citations
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3,741Â citations
TL;DR: The gravity equation has been widely recognized for its consistent empirical success in explaining many different types of flows, such as migration, commuting, tourism, and commodity shipping as mentioned in this paper, but its use for predictive purposes has been inhibited owing to an absence of strong theoretical foundations.
Abstract: Despite the gravity equation's empirical success in "explaining" trade flows, the model's predictive potential has been inhibited by an absence of strong theoretical foundations. A general equilibrium world trade model is presented from which a gravity equation is derived by making certain assumptions, including perfect international product substitutability. If, however, trade flows are differentiated by origin as evidence suggests, the typical gravity equation is misspecified, omitting certain price variables. The last section presents empirical evidence supporting the notion that the gravity equation is a reduced form from a partial equilibrium subsystem of a general equilibrium model with nationally differentiated products. THE "gravity equation" has been long recognized for its consistent empirical success in explaining many different types of flows, such as migration, commuting, tourism, and commodity shipping. Typically, the log-linear equation specifies that a flow from origin i to destination j can be explained by economic forces at the flow's origin, economic forces at the flow's destination, and economic forces either aiding or resisting the flow's movement from origin to destination. In international trade, bilateral gross aggregate trade flows are explained commonly using the following specification: PXi, = fo(yi) (I?) 2(Dij )3(A 1)4u (1) where PXij is the U.S. dollar value of the flow from country i to country j, Yi (Y1) is the U.S. dollar value of nominal GDP in i (j), Dij is the distance from the economic center of i to that of j, Aij is any other factor(s) either aiding or resisting trade between i and j, and u is a log-normally distributed error term with E(ln uij) = 0. This specification was used in Tinbergen (1962), Poyhonen (1963a, 1963b), Pulliainen (1963), Geraci and Prewo (1977), Prewo (1978), and Abrams (1980).1 Table I presents results from estimating a gravity equation similar to (1) for 15 OECD countries' trade flows.2 Coefficient estimates are stable across years and are representative of trade gravity equations. Despite the model's consistently high statistical explanatory power, its use for predictive purposes has been inhibited owing to an absence of strong theoretical foundations. The most common justification-used in Linnemann (1966), Aitken (1973), Geraci and Prewo (1977), Prewo (1978), Abrams (1980), and Sapir (1981)-was developed by Linnemann and asserts that the gravity model is a reduced form from a four-equation partial equilibrium model of export supply and import demand. Prices are always excluded since "they merely adjust to equate supply and demand."3 However, critics have argued that this approach is "loose" and does not explain the multiplicative functional form.4 This study addresses these and other issues in developing further the microeconomic foundations of the gravity equation. The "looseness" critique is addressed by systematically describing assumptions necessary to generate a gravity equation similar to (1) from a general equilibrium framework. Specific, yet intuitively plausible, functions for utility and production generate the equation's multiplicative form. Section I presents a general equilibrium model of world trade derived from utilityand profit-maximizing agent behavior in N countries assuming a single factor of production in Received for publication June 16, 1983. Revision accepted for publication December 12, 1984. *Federal Reserve Bank of Boston. The author is very grateful to J. David Richardson, Robert Baldwin, Rachel McCulloch, James Alm, Saul Schwartz and two anonymous referees for helpful comments on earlier drafts, and Doug Cleveland for research assistance. All errors remain the author's responsibility. The views expressed do not necessarily reflect the views of the Federal Reserve Bank of Boston or the Federal Reserve System. 'Linnemann (1966), Aitken (1973), Sattinger (1978) and Sapir (1981) used the same general specification, but also included exporter and importer populations. Microeconomic foundations of this alternative specification are discussed in Bergstrand (1984). 2The countries are Canada, United States, Japan, BelgiumLuxembourg, Denmark, France, West Germany, Italy, Netherlands, United Kingdom, Austria, Norway, Spain, Sweden, and Switzerland. The adjacency, EEC, and EFTA dummies are explained in the appendix. 3Linnemann (1966), p. 41; Leamer and Stern (1970), p. 146; (Geraci and Prewo (1977), p. 68; Prewo (1978), p. 344; and Sapir (1981), p. 341. 4See, for example, Anderson (1979), p. 106 and Leamer and Stern (1970), p. 158.
2,988Â citations
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TL;DR: In this article, the authors propose a network/search view of international trade in differentiated products and present evidence that supports the view that proximity and common language/colonial ties are more important for differentiated products than for products traded on organized exchanges in matching international buyers and sellers.
Abstract: I propose a network/search view of international trade in differentiated products. I present evidence that supports the view that proximity and common language/colonial ties are more important for differentiated products than for products traded on organized exchanges in matching international buyers and sellers, and that search barriers to trade are higher for differentiated than for homogeneous products. I also discuss alternative explanations for the findings.
2,292Â citations