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

19 Pages Posted: 8 May 2006

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)

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Abstract

A key element missing from the structural gravity literature is an examination of the implied general equilibrium. By design the gravity equation is adept at predicting bilateral trade flows. To make inferences beyond trade flows, however, the theoretic models should be consistent with other observables. Structural econometric estimates from Anderson and van Wincoop (2003) allow us to evaluate their proposed general equilibrium along several dimensions. We find that their gravity model predicts too large a difference between consumer and producer prices; excessive variation in the geographic distribution of consumer price indices; and an exceptionally large portion of output devoted to overcoming trade frictions. Under plausible parameterizations of the model at least 50% of output 'melts' in transit.

Suggested Citation

Balistreri, Edward J. and Hillberry, Russell H., Trade Frictions and Welfare in the Gravity Model: How Much of the Iceberg Melts?. Canadian Journal of Economics, Vol. 39, No. 1, pp. 247-265, February 2006, Available at SSRN: https://ssrn.com/abstract=877409 or http://dx.doi.org/10.1111/j.0008-4085.2006.00346.x

Edward J. Balistreri (Contact Author)

Iowa State University ( email )

260 Heady Hall
Ames, IA 50011
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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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