On Theories Explaining the Success of the Gravity Equation

53 Pages Posted: 20 Jul 2000

See all articles by Simon J. Evenett

Simon J. Evenett

University of Oxford - Said Business School; Centre for Economic Policy Research (CEPR)

Wolfgang Keller

University of Colorado; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: April 1998

Abstract

We analyze two main theories of international trade, the Heckscher-Ohlin theory and the Increasing Returns trade theory, by examining whether they can account for the empirical success of the so-called Gravity Equation. Since versions of both models can generate this prediction, we tackle the model identification problem by conditioning bilateral trade relations on factor endowment differences and the share of intra-industry trade, because only for large factor endowment differences does the Heckscher-Ohlin model generate specialization of production and the Gravity Equation, and it predicts inter-, not intra-industry trade. There are three major findings: First, little production is perfectly specialized due to factor endowment differences, making the perfect specialization version of the Heckscher-Ohlin model an unlikely candidate to explain the empirical success of the Gravity Equation. Second, increasing returns are important causes for perfect product specialization and the Gravity Equation, especially among industrialized countries. Third, to the extent that production is not perfectly specialized across countries, we find support for both Heckscher-Ohlin and Increasing Returns models. Based on these findings, we argue that both models explain different components of the international variation of production patterns and trade volumes, with important implications for productivity growth, labor and macroeconomics.

Suggested Citation

Evenett, Simon J. and Keller, Wolfgang, On Theories Explaining the Success of the Gravity Equation (April 1998). NBER Working Paper No. w6529. Available at SSRN: https://ssrn.com/abstract=226266

Simon J. Evenett (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
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44 1865 288 875 (Phone)
44 1865 288 805 (Fax)

Centre for Economic Policy Research (CEPR)

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Wolfgang Keller

University of Colorado ( email )

Department of Economics
PO Box 256
Boulder, CO 80309
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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