Understanding the Distance Puzzle through the Location of Production

Abstract:     
The estimated effects of distance are unrealistically high (i.e., the magnitude dimension) and persistent over time (i.e., the time dimension) in empirical trade studies, the so-called the distance puzzle. Regarding the magnitude, this paper shows analytically and proves empirically that ignoring the location of production (of exports) results in a significantly high upward bias in estimated distance effects; the results are robust to the consideration of zero-trade observations. Regarding the time dimension, when the distance elasticity of trade is decomposed into the elasticity of substitution and the elasticity of distance (with respect to trade costs) by using production-side data under a CES framework, independent of the estimation methodology used, the median (across goods) effects of distance are constant over time.

Number of Pages in PDF File: 28

Keywords: Elasticity of Demand, International Trade, Trade Ratios, State Exports, the United States

JEL Classification: F12, F13, F14

working papers series