Trade Frictions and Welfare in the Gravity Model: How Much of the Iceberg Melts?

USITC Office of Economics, Working Paper No. 2001-11-B

25 Pages Posted: 8 Dec 2001

See all articles by Edward J. Balistreri

Edward J. Balistreri

Iowa State University

Russell H. Hillberry

University of Melbourne - Department of Economics; World Bank - Development Research Group (DECRG)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2004

Abstract

A key element missing from the structural gravity literature is a legitimate validation of theory. By design the reduced-form gravity equation is adept at predicting bilateral trade flows. To make inferences beyond trade flows, however, theoretic models should be consistent with other observable facts. Structural econometric estimates from Anderson and van Wincoop (2003) allow us to evaluate the extensive form of their theoretical gravity model along several dimensions. Under the standard assumption of identical consumer preferences, we find that the model predicts 1) too large a difference between consumer and producer prices, 2) excessive variation in the geographic distribution of consumer price indices, and 3) an exceptionally large transport sector. Under plausible parameterizations of the model at least 50% of output "melts" in transit.

Keywords: Trade Frictions, Gravity Equation

JEL Classification: F10, F17

Suggested Citation

Balistreri, Edward J. and Hillberry, Russell H., Trade Frictions and Welfare in the Gravity Model: How Much of the Iceberg Melts? (August 2004). USITC Office of Economics, Working Paper No. 2001-11-B, Available at SSRN: https://ssrn.com/abstract=292423 or http://dx.doi.org/10.2139/ssrn.292423

Edward J. Balistreri (Contact Author)

Iowa State University ( email )

260 Heady Hall
Ames, IA 50011
United States
3032531674 (Phone)

Russell H. Hillberry

University of Melbourne - Department of Economics ( email )

Melbourne, 3010
Australia

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

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