Gravity

AGRODEP Technical Note TN-04
April 2013

The Gravity Model in International Trade
Version 2

Luca Salvatici

AGRODEP Technical Notes are designed to document state-of-the-art tools and methods. They are circulated in order to help AGRODEP members address technical issues in their use of models and data. The Technical Notes have been reviewed but have not been subject to a formal external peer review via IFPRI’s Publications Review Committee; any opinions expressed are those of the author(s) and do not necessarily reflect the opinions of AGRODEP or of
IFPRI.

2
Abstract Since Jan Tinbergen’s original formulation (Tinbergen 1962), gravity has long been

one of the most successful empirical models in economics. Incorporating the theoretical foundations of gravity into recent practice has led to a richer and more accurate estimation and interpretation of the spatial relations described by gravity. Recent developments are reviewed here and suggestions are made for promising future research.

3

1. Introduction
This gravity guide provides a literature review and a methodological discussion about the gravity equation. From the first conceptualisation of Tinbergen (1962) the gravity equation has been used time and again to empirically analyse trade between countries. It has been defined as the workhorse of international trade and its ability to correctly approximate bilateral trade flows makes it one of the most stable empirical relationships in economics (Leamer and Levinsohn
1995).
Over the years there has been dramatic progress both in understanding the theoretical basis for the equation and in improving its empirical estimation. This review cannot and does not intend to be a complete survey of a huge (and still increasing) literature. The aim is to provide the reader with an informed perspective on the empirical issues associated with the estimation of the gravity equation. To this end, we deliberately scant or omit some topics in

References: Anderson, James E, (1979). "A Theoretical Foundation for the Gravity Equation," American Economic Review, American Economic Association, vol. 69(1), pages 106-16, March. Anderson JE (2011) The Gravity model. Annual Review of Economics, 3. Anderson JE, van Wincoop E (2003) Gravity with gravitas: A solution to the border puzzle. Amer. Econ. Rev. Anderson JE, van Wincoop E (2004) Trade costs. J of Econ Lit, 42:691-751. Anderson JE, Yotov YV (2010) The changing incidence of geography. Am Econ Rev, 100(5), 2157-2186. Anderson, JE (1979) A theoretical foundation for the gravity equation. Amer. Econ. Rev. 69: 106-116. Angrist JC, Pischke J-S (2008) Mostly harmless econometrics: an empiricist 's companion. Princeton University Press, Princeton Arkolakis C, Costinot A, Andres Rodriguez-Clare A (2012) New Trade Models, Same Old Gains?, American Economic Review, American Economic Association, vol Armington, PS (1969) A theory of demand for products distinguished by place of production, IMF Staff Papers, 16, pp. 159-178. Baier SL, Bergstrand JH (2001) The growth of world trade: tariffs, transport costs and income similarity. J. Int. Baier SL, Bergstrand JH (2004) Economic determinants of free trade agreements. J. Int. Econ. 64 (1): 29–63 Baier SL, Bergstrand JH (2007) Do free trade agreements actually increase members’ international trade? J. Baier SL, Bergstrand JH (2009) Bonus vetus OLS: a simple method for approximating international trade-cost effects using the gravity equation Baldwin R, Taglioni D (2006) Gravity for dummies and dummies for gravity equations. NBER Working Paper N° 12516. Bergstrand JH (1985) The gravity equation in international trade: some microeconomic foundations and empirical evidence. Rev Econ Stat 67: 474-481. Bergstrand, JH (1989) The generalized gravity equation, monopolistic competition, and the factor-proportions theory in international trade Bergstrand JH, Egger P. (2010), Gravity Equations and Economic Frictions in the World Economy: A Survey,” University of Notre Dame Notre Dame Economics Working Paper Series, June. Bernard, Andrew B., Jonathan Eaton, J. Bradford Jensen, and Samuel S. Kortum, (2003) "Plants and Productivity in International Trade", American Economic Review, 93(4), 1268-1290 Bernard A, Jensen JB, Redding S, Schott P (2007) Firms in international trade Bernard, AB. Jensen, JB, Redding, SJ, Schott, PK, (2009) The Margins of US Trade, American Economic Review, American Economic Association, vol. 99(2), pages 487-93. Bernard, AB. Jensen, JB, Redding, SJ, Schott, PK, (2011) The Empirics of Firm Heterogeneity and International Trade, NBER Working Paper No. 17627. Blum BS, Goldfarb A (2006) Does the internet defy the law of gravity? J Int Econ 70(2):384-405. Brun J-F, Carrère C, Guillaumont P, de Melo J (2005) Has distance died? Evidence from a panel gravity model. World Bank Econ Rev 19:99-120. Bun M, Klaassen F (2002) The importance of dynamics in panel gravity models of trade. Tinbergen Institute Discussion Paper, No Burger MJ, van Oort FG, Linders GM (2009) On the specification of the gravity model of trade: zeros, excess zeros and zero-inflated estimation Cameron AC, Trivedi PK (2005) Microeconometrics. Methods and Applications. Cambridge University Press, Cambridge. Cardamone P (2007) A survey of the assessments of the effectiveness of Preferential Trade Agreements using gravity models Chaney T. (2011) The Network Structure of International Trade, NBER Working Papers 16753, National Bureau of Economic Research. Chaney T (2008) Distorted gravity: the Intensive and extensive margins of International trade. Am Econ Rev 98:1701-1721. Cipollina M, Salvatici L (2008) Measuring Protection: Mission Impossible?. Journal of Economic Surveys, Vol Cipollina M, Salvatici L (2010a) The impact of European Union agricultural preferences. J of Econ Policy Reform 13:87-106. 23 Cipollina M, Salvatici L (2010b) Reciprocal trade agreements in gravity models: A Meta-Analysis Cipollina M, Laborde D., Salvatici L (2011) Do preferential Trade Policies (Actually) Increase Exports? A Comparison between EU and US trade policies, SIE - Società Italiana degli Economisti, 52.ma Riunione Costantini J, Melitz MJ (2008) The dynamics of firm-level adjustment to trade liberalization. In: Helpman E, Marin D, Verdier T (eds) The organization of firms in a global economy MA Daude C, Stein E (2007) Longitude matters: time zones and the location of foreign direct investment De Benedictis L, De Santis R, Vicarelli C (2005) Hub-and-Spoke or else? Free Trade Agreements in the enlarged EU. European Journal of Comparative Econ 2:245-260. De Benedictis L and Salvatici L eds. (2011), The Trade Impact of European Union Preferential Policies: an analysis through gravity models, Springer. De Benedictis L, Vicarelli C (2005) Trade potentials in gravity panel data models. Topics in Econ Anal & Policy 5(1):1-31 De Benedictis L, Vicarelli C (2009) Dummies for gravity and gravity for policies: mission impossible? Mimeo. De Benedictis L, Taglioni D (2011) The Gravity Model in International Trade, in “The Trade Impact of European Union Preferential Policies: an analysis through gravity models”, Luca De Benedictis and Luca Salvatici (eds.), Springer. Disdier AC, Head K (2008) The puzzling persistence of the distance effect on bilateral trade. R E Stat 90(1):37-48. Eaton J, Kortum S (2002) Technology, geography and trade. Econometrica 70(5):1741-1779. Engel C. (2002), Comment on Anderson and van Wincoop in Brookings Trade Forum 2001, Susan Collins and Dani Rodrik, eds., Washington: The Brookings Institution. Feenstra RC (2003) Advanced international trade: theory and evidence. Princeton University Press, Princeton Felbermayr GJ, Kohler W (2006) Exploring the intensive and extensive margins of world trade Fidrmuc J (2009) Gravity models in integrated panels. Empir Econ 37:435-446 Francois J, Hoekman B, Manchin M (2006) Preference erosion and multilateral trade liberalization Bank Econ Rev 20:197-216 Frankel J (1997) Regional trading blocs Guiso L, Sapienza P, Zingales L (2009) Cultural biases in economic exchange? The Quart J of Econ 124(3):1095-1131. Harrigan J (2010) Airplanes and comparative advantage. J Int Econ 82(2):181-194. Head K, Mayer T (2000) Non-Europe: the magnitude and causes of market fragmentation in the EU. Weltwirtschaftliches Archiv 136 (2): 285– 314. Head K, Mayer T (2004) Market potential and the location of Japanese investment in the European Union. R E Stat. Heckman J (1979) Sample selection bias as a specification error. Econometrica 47(1):153-161. Helpman E, Krugman P (1985) Market structure and foreign trade: increasing returns, imperfect competition and the international economy.MIT Press, Cambridge Helpman E, Melitz M, Rubinstein Y (2008) Estimating trade flows: trading partners and trading volumes. Hummels D (1999) Toward a geography of trade costs. GTAP Working Paper 17, Global Trade Analysis Project, Purdue University. Hummels D (2007) Transportation Costs and International Trade in the Second Era of Globalization, Journal of Economic Perspectives 21 pp Hummels D, Lugovskyy V (2006) Are matched partner trade statistics a usable measure of transport costs? Rev of Int Econ 14(1):69-86. Imbens G, Wooldridge J (2009) Recent developments in the econometrics of program evaluation. J of Econ Lit 47(1): 5–86 Jacks D, Meissner C, Novy D (2008) Trade costs. 1870-2000. Am Econ Rev 98(2):529-534. Lawless M (2010) Deconstructing gravity: trade costs and extensive and intensive margins. Can J Econ 43(4):1149-1172. Leamer EE, Levinsohn J (1995) International trade theory: the evidence. In: Grossman G, Rogoff K (eds) Handbook of International Economics, Volume 3 Limao N and Venables T (2001) Infrastructure, geographical disadvantage and transport costs. World Bank