Controlling for Heterogeneity in Gravity Models of Trade

More documents

Recommendations

Info

ln Xijt= α0+ αt+ β1lnYit+ β2lnYjt+ β3ln Nit+ β4ln Njt+ δ1ln Dij+ δ2Cij+ λLij+ εijt; (4)where α 0 is the portion of the intercept that is common to all years and trading pairs, anddenotes the year-specific effect common to all trading pairs. Note that we omit the dummy for1991 so as to avoid collinearity. We suppress the regression equation for the basic version of themodel (PCSb), as it is the same as (4) except for the restriction that β = β 0 . The expected3 4 =signs for the coefficients are the same as for the CS models, except that the PCS models havetime dummies to consider. We take the time dummies as an indicator of the extent of“globalization”, which we define as the common trend towards greater real trading volumes,independent of the sizes of the economies.The regression results for PCSa and PCSb are reported in the first two columns of Table2. Unsurprisingly, the results are similar to those from the single-year cross-sections. The CSand PCS models yield roughly the same elasticities on GDPs and distance, and have roughly thesame predictive power as measured by2R . Note, however, that because of the large number ofobservations relative to the CS models, the coefficients on the countries’ populations and oncontiguity are statistically significant. Comparing the two versions of the PCS model, althoughPCSa and PCSb yield very similar results, a likelihood ratio test rejects the null hypothesis thatαtthey are statistically the same. 10We therefore conclude that the augmented version of the gravitymodel is preferred to the basic model when using a pooled cross-section.According to the estimates of the preferred PCSa model: (i) a 10% rise in a country’s10 This is with a critical value of 5.99 at the 5% level, and χ 2 (2) = 14.94.10
GDP should be associated with a 6.2% rise in its exports and an 8.5% rise in its imports, all elseconstant; (ii) exports tend to be labor-intensive and income elastic (luxury goods), as indicated byWKHSRVLWLYHVLJQIRU 3DQGWKHQHJDWLYHVLJQIRU 4; and (iii) a country will export 82% less to amarket that is twice as distant as another otherwise-identical market, 20% more to a country thatis contiguous, and 70% more to a country with the same first language. Finally, we take the factthat our time dummies are not statistically different from zero to mean that globalization, asdefined above, was not an important factor in increasing trading volumes during the period.The general conclusion from our estimation of standard gravity models is that they yieldstable results that do not differ a great deal over the sample period, nor between the basic andaugmented versions. We also conclude that the augmented version is preferred statistically,although the basic version provides predictions of trade volumes that are nearly as accurate.Finally, the estimates we obtain are not greatly out of line with those obtained previously in theliterature.One should be cautious before concluding that there are no empirical problems with thesestandard methods. This is clear from the upper-left panel of Figure 1, which plots the residualsfor the PCSa model. The strong positive relationship between the residuals and the level ofexports indicates that the PCSa model tends to underestimate the level of trade when the actuallevel is high, and overestimates it when the actual level is low. To our knowledge, this bias hasnot been recognized in the literature. Because the gravity model is used to establish baselinelevels of trade, it is important to have unbiased estimates the coefficients on the gravity variables,11
Page 1 and 2: WORKING PAPER SERIESControlling for
Page 3 and 4: Controlling for Heterogeneity in Gr
Page 5 and 6: simply on the basis of goodness of
Page 8 and 9: independent variables are assumed t
Page 10: GDPs, their populations, and the di
Page 15 and 16: that it may be different for each d
Page 17 and 18: cross-section results, the year dum
Page 19 and 20: country-pair effects from the FE mo
Page 21 and 22: and BEa results differ enough to re
Page 23 and 24: primary change over the period was
Page 25 and 26: 7. ConclusionsThe objective of this
Page 27 and 28: ReferencesAitken, N. D., 1973, “T
Page 29 and 30: Table 1: Regression results for sin
Page 31 and 32: Table 3: Regression results with in

Controlling for Heterogeneity in Gravity Models of Trade

Create successful ePaper yourself

Delete template?

Save as template?