Full Grav Lecture GE Yotov ECON644

GENERAL EQUILIBRIUM ANALYSIS WITH THE
STRUCTURAL GRAVITY MODEL
Yoto V. Yotov
ECON 644, School of Economics
Drexel University
February 25, 2021
Y. V. Yotov Trade Policy Effects with Structural Gravity ECON 644, Winter, 20/21
Partial vs. General Equilibrium
Outline: GE Analysis and Applications
I On the Structural GE Effects of Trade Policy

I GE Analysis with Gravity: A Standard Approach
I GE Analysis with Gravity: An Estimation Approach
I Gravity Applications in a General Equilibrium
I A World with No Borders
I On the GE Effects of NAFTA
I Questions and Discussion
I Computer Session II: GE Gravity Analysis in Stata
Organizational Items
I Problem Sets
I Project Presentations
I Project Papers
On the Structural GE Effects of Trade Policy
On the Structural Effects of Trade Policy
1−σ
tij Yi Yj
Structural Gravity: Xij = Πi Pj Y ,
P tij 1−σ Yi
Inward Resistance: Pj1−σ = i Πi Y,
P tij 1−σ Yj
Outward Resistance: Π1−σ
i = j Pj Y,
Income/GDP: Yj = Qj pj ,
1
Market Clearance: (Yj /Y ) 1−σ
pj = βj Π j .
1−σ
tij Yi Yj
‘Partial Equilibrium’ Xij = Πi Pj Y ,
P tij 1−σ Yi
Inward Resistance: Pj1−σ = i Πi Y,
P tij 1−σ Yj
Outward Resistance: Π1−σ
i = j Pj Y,
Income/GDP: Yj = Qj pj .
1
pj

= βj Π j .
1−σ
tij Yi Yj

1−σ P tij 1−σ Yi
P = Y,


 j
 i Πi
‘Conditional’ GE
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj
Income/GDP: Yj = Q j pj .
1
pj = βj Π j .
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j


‘Full Endowment’ GE 1

 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
1−σ
tij Yi Yj

P = Y,


 j
 i Πi
 P tij 1−σ Yj
 Π1−σ

= Y,

i j Pj

Y = Q j pj .
 j



 pj (Yj /Y ) 1−σ
= .

βj Π j
GE Analysis with Structural Gravity:
A Standard Approach
A Standard Approach to Counterfactuals
I Step 1: Solve the baseline gravity model.
I Step 2: Define a counterfactual scenario.
I Step 3: Solve the counterfactual model.
I Step 4: Collect, construct, and report indexes of interest.
I Step 5: Construct confidence intervals.
Counterfactuals with Structural Gravity: A Standard Approach
I Step 1.a: Obtain estimates of trade costs and trade

elasticities.
Xij,t = exp[πi,t + χj,t + µij + η1 FTAij,t + η2 ESi,t × INTLij ] ×

exp[η3 MFNj,t × INTLij ] + ij,t .
This step will deliver estimates of time-invariant bilateral

trade costs and of the elasticities of trade with respect to
trade policy.
I Step 1.a: Obtain estimates of trade costs and trade

elasticities.

This step will deliver estimates of time-invariant bilateral

trade costs and of the elasticities of trade with respect to
trade policy.
NOTE: The estimates of the trade costs can be constructed

directly from the data using tetrads or other ratio methods.
Careful attention should be paid to any normalizations used

in the process of trade cost construction.
I Step 1.b: Recover Additional Parameters and

Exogenous Variables.
Obtain values for all remaining parameters and exogenous
unobservable variables in order to ensure that the model is
perfectly consistent with the data in the baseline scenario.
I Step 1.b: Recover Additional Parameters and

Exogenous Variables.
Obtain values for all remaining parameters and exogenous
unobservable variables in order to ensure that the model is
perfectly consistent with the data in the baseline scenario.
NOTE: This step is optional because the model can be

solved in changes, cf. Dekle, Eaton, Kortum (2008), which
will eliminate those exogenous terms from the system.

I Step 1.c: Construct Baseline Indexes.

I Baseline Trade Costs
1−σ
BLN
btij,t = exp[µ̂ij + η̂1 FTAij,t + η̂2 ESi,t × INTLij + η̂3 MFNj,t × INTLij ],
I As well as any other indexes of interest, e.g Real GDP.
I Step 1.c: Construct Baseline Indexes.

I Baseline Trade Costs
1−σ
BLN
btij,t = exp[µ̂ij + η̂1 FTAij,t + η̂2 ESi,t × INTLij + η̂3 MFNj,t × INTLij ],
I As well as any other indexes of interest, e.g Real GDP.
NOTE: If trade costs are calibrated, one needs to further

borrow trade policy elasticity estimates from literature.
Alternatively, one may simulate the effects of a hypothetical

percentage fall in trade costs.
I Step 2: Define a Counterfactual Scenario.
Define the policy experiment by changing the definition

of the policy variables. Alternatively, one may change
the values for the trade cost elasticities, the β’s.
1−σ
CFL
btij,t =exp[µ̂ij + η̂1 FTACFL CFL CFL
ij,t + η̂2 ESi,t × INTLij + η̂3 MFNj,t × INTLij ].
where: CFL stands for ‘counterfactual’; and ‘the hat’

symbol denotes estimates.

I Step 3: Solve the Counterfactual Model.

Use the values from Steps 1 and 2, to solve the structural gravity
system in the counterfactual scenario. A two-step approach is
instructive and informative:
I Step 3.a: Obtain ‘Conditional’ GE Effects. The ‘conditional’ (for

given output and expenditure) general equilibrium effects of trade
policy captured by the changes in the multilateral resistances.
These are the total effects of trade policy on trade costs.
I Step 3.b: Obtain ‘Full Endowment’ GE Effects. This step

endogenizes the value of production to obtain ‘Full Endowment’
General Equilibrium response to trade policy changes.

I Step 4: Collect, Construct and Report Indexes of Interest.
Collect, and report indexes of interest:

CFL BLN
IND
d
i,t − IND
d
i,t
∆%IND
di =
BLN
× 100,
IND
d
i,t
where: IND
d can be any index of interest, e.g. MR terms, factory
gate prices, ToT, real consumption, etc.

I Step 5: Construct Confidence Intervals.
Generate sufficient number of sets of bootstrapped gravity

estimates according to Step 1. Calculate 95% centered
bootstrap confidence intervals as follows:

B B
2IND − IND (195) ; 2IND − IND (5) ,
d d d d
B B
where: IND
d and IND
(5)
d
(195) are, respectively, the 5th and the
195th indexes
from the ranked (from bottom to top) bootstrap
B B B
sample INDd , IND d , ..., IND .

d
(1) (2) (200)
GE Analysis with Structural Gravity:
An Estimation Approach
Counterfactuals with Structural Gravity: An Estimation Approach
I Obtaining own trade costs and especially elasticity estimates from same
data used in counterfactual analysis is desirable.

Xij,t = exp[πi,t + χj,t + Tij,t β] + ij,t ,
data used in counterfactual analysis is desirable. Precious in fact!!
Xij,t = exp[πj,t + χi,t + ] + εij,t .
I Use fixed effects as powerful (but dangerous!) weapons to get to trade

costs and elasticities.

costs and elasticities. Blow up the Bank to get to treasure inside.

I But theoretical gravity, and corresponding counterfactual experiments,

rely on / assume one-to-one mapping between fixed effects and
structural gravity terms.


structural gravity terms. Fixed effects may cause significant damage.


I How much information do we miss when we move from estimating

gravity to relying on it for counterfactuals?



gravity to relying on it for counterfactuals? What is the damage?



I No damage at all!



I No damage at all! When gravity is estimated with PPML, the structural

gravity terms explain 100% of the variability in the fixed effects.



I No damage at all! When gravity is estimated with PPML, the structural

gravity terms explain 100% of the variability in the fixed effects. We can
use ‘blueprints’ to re-build the Bank with treasure in our pocket!!
I Following the estimation recommendations from the previous lecture,

Anderson and Yotov (2012) discover a striking (almost perfect) match
between the directional fixed effects from gravity estimations and their
structural counterparts.

I Arvis & Shepherd (2013) and Fally (2015) uncover properties of PPML
that satisfy:
Yi,t Ej,t
exp(π̂i,t ) = and exp(χ̂j,t ) = ,
Π̂1−σ
i,t
1−σ
P̂j,t

I Arvis & Shepherd (2013) and Fally (2015) uncover properties of PPML
that satisfy:
Yi,t Ej,t
exp(π̂i,t ) = and exp(χ̂j,t ) = ,
Π̂1−σ
i,t
1−σ
P̂j,t
I Anderson, Larch and Yotov (2018) capitalize on this PPML property and
implement the full structure of the gravity model by endogenizing the

value of output to offer a simple estimating procedure to perform
structural GE gravity analysis in standard statistical packages.
General Equilibrium (GE) PPML:
Estimating GE Trade Policy Effects (with Stata)
Step 1’: Solve the Baseline Gravity Model.
I Step 1’a: Obtain estimates of trade costs and trade

elasticities.
Use PPML, panel data with intervals, exporter-time fixed effects,
importer-time fixed effects, and pair fixed effects to estimate:
Xij,t = exp[Tij,t β + πi,t + χj,t ] × ij,t ,
Step 1’: Solve the Baseline Gravity Model.
I Step 1’a: Obtain estimates of trade costs and trade

elasticities.
Use PPML, panel data with intervals, exporter-time fixed effects,
importer-time fixed effects, and pair fixed effects to estimate:
Xij,t = exp[Tij,t β + πi,t + χj,t ] × ij,t ,
Accounting for perfect collinearity, imposing a normalization for

the MRs, and estimating structural gravity without a constant
implies: πi,t = Yi,t /(Π1−σ

i,t Yt ) and χ0,t = E0,t , where χ0,t = E0,t is
the dropped fixed effect.
On the Choice of Reference Country
NOTE:
I Select a country with good data.
I Select a country that is ‘remote’ from the counterfactual.
On the Vector of Bilateral Trade Costs
NOTE:
I The estimates of the trade cost elasticities can be obtained with
any other estimator or taken from the literature! In that case:
Xij,t = exp[Tij,t β̄ + πi,t + χj,t ] × ij,t .
I One can also take the whole trade cost term from the literature,
e.g. as constructed with the tetrads method. In that case:
Xij,t = exp[T̄ij,t + πi,t + χj,t ] × ij,t .
I Finally, one can use “estibrated” trade costs T̃ij = Tij βe × ln (e

εij ):

Xij,t = exp[T̃ij,t + πi,t + χj,t ] × ij,t .
I Step 1’b: Construct Baseline Indexes.

Use the estimates of the gravity fixed effects together with data on
output and expenditure to construct the multilateral resistances:
Yi,t E0,t
Π1−σ
i,t = ×
exp(π̂i,t ) Yt
and
Ej,t 1
Pj,t 1−σ = × ,
exp(χ̂j,t ) E0,t
P P
where, by construction, Yi,t = j Xij,t and Ej,t = i Xij,t .

Construct any other baseline GE indexes of interest (e.g. real

consumption, terms of trade, etc.).
I Step 2’: Define Counterfactual Experiment.
Define the policy experiment by changing the definition of

the policy variables in vector Tij,t . Alternatively, one may
change the values for the trade cost elasticities, the β’s.
Step 3’: Solve the Counterfactual Model.

I Step 3’a: Obtain ‘Conditional’ GE Effects.
Xij,t = exp[TCFL CFL CFL CFL

ij,t β̄ + πi,t + χj,t ] + ij,t ,
where, the ‘bar ’ symbol is used to capture the fact that certain
coefficients are constrained to be equal to their estimated counterparts
from Equation in Step 1’ or to their new values as defined in Step 2’.
Repeat Step 1’a with the new gravity fixed effects estimates and the
original data on output and expenditure to construct the ‘Conditional’ GE

estimates of the MRs and construct any other GE indexes of interest.
I Step 3’b: Estimate ‘Full Endowment’ Gravity.
This step delivers estimates of the fixed effects that

correspond to the ‘Full Endowment’ scenario.
This step is performed in a loop with three stages.
I (i): Allow for Changes in Factory-gate Prices.

Use the market clearing conditions:
1
Yi 1−σ 1
pi = , ∀i
Y βi Πi
and the definition of the exporter fixed effects:

Yi,t
exp(π̂i,t ) = ,
Yt Π̂1−σ
i,t
to translate the ‘conditional’ GE effects on the MR terms to ‘first-order’

changes in factory-gate prices as a function of the gravity fixed effects:
! 1
CFL CFL 1−σ

pi,t exp(π̂i,t )
=
pi,t exp(π̂i,t )
I (ii): Allow for Endogenous Income, Expenditure, and Trade.

The goal is to allow for endogenous response in the value of output
CFL CFL CFL CFL
Yi,t = (pi,t /pi,t )Yi,t and expenditure Ej,t = (pj,t /pj,t )Ej,t .

CFL CFL CFL CFL
Output and expenditure, however, are controlled for by the estimation

fixed effects and, because these variables do not appear explicitly in
the gravity equation, their changes cannot be accounted for directly.

CFL CFL CFL CFL
Output and expenditure, however, are controlled for by the estimation

fixed effects and, because these variables do not appear explicitly in
the gravity equation, their changes cannot be accounted for directly.
To overcome this obstacle, we use the structural gravity equation to

translate the changes in output, expenditure and MRs into changes in
trade flows, which enter the estimating gravity equation directly:
CFL
1−σ
tij,t CFL CFL
Π1−σ 1−σ
CFL Yi,t Ej,t i,t Pj,t
Xij,t = 1−σ CFL CFL Xij,t ,

tij,t Yi,t Ej,t

Π1−σ
i,t P 1−σ
j,t
CFL
1−σ 1−σ
= exp TCFL

where tij,t ij,t β̄ and tij,t = exp (Tij,t β).
I (iii): Estimate ‘Full Endowment’ Model.
I Estimate gravity with the new values for trade.
The idea is that PPML will translate the initial response of

factory-gate prices into changes in the gravity fixed effects,
i.e. into changes in the MRs and in output and expenditure.

I Repeat step (i) to obtain a new set of factory-gate prices.
I Repeat step (ii) to obtain new values of trade (and income).
I Iterate until convergence, i.e. until the change in each of the

factory-gate prices is zero.


I Repeat step (i) to obtain a new set of factory-gate prices.
I Repeat step (ii) to obtain new values of trade (and income).
I Iterate until convergence, i.e. until the change in each of the

factory-gate prices is zero.

I (iv): Construct ‘Full Endowment’ GE Effects.
I Step 4’: Collect, Construct and Report Indexes of Interest.

CFL BLN
IND i,t − IND i,t
d d
∆%IND
di =
BLN
× 100,
IND
d
i,t
where: IND
d can be any index of interest, e.g. MR terms, factory
gate prices, ToT, real consumption, etc.
I Step 5’: Construct Confidence Intervals.
GE PPML: Estimating General Equilibrium
Trade Policy Effects. Applications
Applications
I. Trade Without Borders

I Hypothetical scenario that removes all international borders to
trade in manufactures for 40 countries.
I Quantification of the effects of an effective multilateral trade
facilitation exercise, i.e. effects of globalization in the 90s.
II. On the GE Effects of NAFTA
Data
Period: 1986-2006
Regions: 69 countries/regions
Products: Total Manufacturing
Variables & Data Sources
Variable Description Data Source
Xij Bilateral trade flows TradeProd (CEPII), COMTRADE
Yi Industrial Output Level TradeProd (CEPII), UNIDO
RTAij Regional Agreements WTO, Mario Larch’s RTA Database
tij Gravity variables CEPII’s Distances Database
Trade Without Borders: An Application
Trade Without Borders
I Estimate gravity to obtain partial ‘border’ effects:

Xij = exp -0.791 ln DISTij + 0.674CNTGij − 2.474BRDRij + π bj + b
bi + χ ij .
(0.050) (0.107) (0.119)
International borders decrease trade by 92%, (eη̂BRDR − 1) × 100, a cost

equivalent to 51%, (e−η̂BRDR /σ̂ − 1) × 100 average tariff (at σ = 6).

bi + χ ij .
(0.050) (0.107) (0.119)

I Obtain ‘Conditional’ GE effects of borders on trade and welfare:

P
j6=i X̂ij
0
P
j6=i X̂ij

bi + χ ij .
(0.050) (0.107) (0.119)

I Obtain ‘Conditional’ GE effects of borders on trade and welfare:

P
j6=i X̂ij
0
P
j6=i X̂ij
I Obtain ‘Full’ GE effects of borders on trade and on welfare:

Wi \i
rGDP Ŷi /P̂i p̂i /P̂i
= = = .
Wi0 \ 0
RGDP i 0
Ŷi /P̂i0
p̂i0 /P̂i0
Trade Without Borders: Cnd’tl Exports
Cnd'tl Exports
150
USA
JPN
AUS
Cnd'tl Exports Stata
100
KOR
GBR
ISR
BRA
ROW
CHN
ITA
ESP
ZZZ
FRA
MEX
CRI
50
ROM
NLD
BLX
GRC
CHL
COL
TUR
ARG
ECU
PRT
CHE
IRL
POL
FIN
DNK
NOR
SWE
AUT
HUN
CAN
MAR
TUN
ISL
URY
BOL
BGR

0
0 50 100 150
Cnd'tl Exports Matlab
Trade Without Borders: Cnd’tl Real GDP
Cnd'tl Real GDP

15 CAN
BOL
ECU
ISL
BGR
URY
MEX
COL
CRI
MAR
10
TUN
GRC
NOR
Cnd'tl Real GDP Stata
PRT
POL
AUT
DNK
HUN
CHL
TUR
SWE
ARG
CHE
FIN
BLX
ESP
5
ROM
NLD
AUS
FRA
ROW
IRL
ISR
GBR
ITA
BRA
ZZZ
0
USA
KOR
CHN
-5
JPN
-5 0 5 10 15
Cnd'tl Real GDP Matlab
Trade Without Borders: Full GE Exports
Full GE Exports
200
USA
150
Full GE Exports Stata
JPN
AUS
KOR
GBR
ISR
ROW
BRA
CHN
100
ITA
ESP
ZZZ
FRA
MEX
CRI
ROM
NLD
BLX
GRC
CHL
COL
TUR
ARG
ECU
CHE
PRT
POL
IRL
DNK
FIN
NOR
CAN
50
SWE
AUT
HUN
MAR
TUN
ISL
URY
BOL
BGR

0
0 50 100 150 200

Full GE Exports Matlab
Trade Without Borders: Full GE Real GDP
Full GE Real GDP

40
BOL
CAN
ISL
BGR
URY
MAR
TUN
ECU
MEX
COL
NOR
30
AUT
DNK
Full GE Real GDP Stata
CRI
POL
HUN
PRT
GRC
SWE
CHL
FIN
CHE
ARG
TUR
BLX
IRL
NLD
ROM
ESP
FRA
20
ROW
AUS
ITA
ISR
BRA
GBR
ZZZ
KOR
CHN
10
JPN
USA

0
0 10 20 30 40
Full GE Real GDP Matlab
On the GE Effects of NAFTA: An Application
On the GE Effects of NAFTA
I Estimate gravity to obtain FTA effects:
Xij,t = exp[πi,t + χj,t + µij + 0.557RTAij,t ] + ij,t .

(0.056)
RTAs from the 90s have lead to 75%, (eη̂RTA − 1) × 100, increase in
trade and to 9.7%, (eη̂RTA /σ̂ − 1) × 100, at σ = 6, decrease in tariffs.

(0.056)
I Obtain ‘Conditional’ GE effects of NAFTA on Exports:

P
j6=i X̂ij
0
P
j6=i X̂ij

(0.056)
I Obtain ‘Conditional’ GE effects of NAFTA on Exports:

P
j6=i X̂ij
0
P
j6=i X̂ij
I Obtain ‘Full’ GE effects of NAFTA on Trade (as before) and on Welfare:

Wi \i
rGDP Ŷi /P̂i p̂i /P̂i
= = = .
Wi0 \ i
RGDP 0 0
Ŷi /P̂i0
p̂i0 /P̂i0
‘Partial’
P ‘Conditional’
P P ‘Full Endowment GE
Country %∆ j6=i Xij %∆ j6=i Xij %∆ j6=i Xij %∆W %∆P %∆p
Argentina 0.00 -0.66 -0.69 -0.01 0.01 0.00
Brazil 0.00 -0.65 -0.69 -0.01 -0.01 -0.02
Bulgaria 0.00 -0.05 -0.05 -0.00 -0.00 -0.01
Canada 55.05 34.99 37.46 3.40 -1.48 1.87
Chile 0.00 -0.81 -0.83 -0.03 0.01 -0.03
China 0.00 -0.34 -0.38 -0.01 -0.01 -0.02
Colombia 0.00 -1.80 -1.73 -0.03 0.09 0.06
Costa Rica 0.00 -1.03 -1.04 -0.07 0.06 -0.01
Germany 0.00 -0.14 -0.17 -0.01 0.00 -0.01
Mexico 56.65 41.64 43.51 3.81 -2.40 1.21
Spain 0.00 -0.13 -0.15 -0.01 0.00 -0.01
Tunisia 0.00 -0.04 -0.07 -0.00 0.00 0.00
UK 0.00 -0.23 -0.25 -0.01 0.01 0.00
USA 18.83 14.48 14.88 0.33 -0.18 0.11
‘Conditional’ IMR Indexes: Matlab vs. Stata
1.5
Conditional IMRs from Fixed Effects (Stata)
.5 1

0
0 .5 1 1.5
Conditional IMRs from Gravity System (Matlab)
‘Conditional’ OMR Indexes: Matlab vs. Stata
.3
Conditional OMRs from Fixed Effects (Stata)
.1 .2

0
0 .1 .2 .3
Conditional OMRs from Gravity System (Matlab)
‘Full Endowment’ IMR Indexes: Matlab vs. Stata
1.5
IMRs from Fixed Effects (Stata)
.5 1

0
0 .5 1 1.5
IMRs from Gravity System (Matlab)
‘Full Endowment’ OMR Indexes: Matlab vs. Stata
.3
OMRs from Fixed Effects (Stata)
.1 .2

0
0 .1 .2 .3
OMRs from Gravity System (Matlab)
‘Full Endowment’ Mill Prices: Matlab vs. Stata
1
Facroty-gate Prices from Fixed Effects (Stata)
.98 .99

.97
.97 .98 .99 1

Facroty-gate Prices from Gravity System (Matlab)
Subject to rounding error, the GE results from
Stata and from Matlab are always identical!!
Lecture Summary: GE Analysis and Applications
I On the Structural GE Effects of Trade Policy

I GE Analysis with Gravity: A Standard Approach
I GE Analysis with Gravity: An Estimation Approach
I Gravity Applications in a General Equilibrium
I A World with No Borders
I On the GE Effects of NAFTA
Questions, Suggestions, Complaints?
Let’s Get Our Hands Dirty:
Estimations and GE Gravity Analysis with Stata

Full Grav Lecture GE Yotov ECON644

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GENERAL EQUILIBRIUM ANALYSIS WITH THE

STRUCTURAL GRAVITY MODEL

I On the Structural GE Effects of Trade Policy

I Questions and Discussion

I Computer Session II: GE Gravity Analysis in Stata

I Step 1: Solve the baseline gravity model.

I Step 2: Define a counterfactual scenario.

I Step 3: Solve the counterfactual model.

I Step 4: Collect, construct, and report indexes of interest.

I Step 5: Construct confidence intervals.

I Step 1.a: Obtain estimates of trade costs and trade

Xij,t = exp[πi,t + χj,t + µij + η1 FTAij,t + η2 ESi,t × INTLij ] ×

This step will deliver estimates of time-invariant bilateral

I Step 1.a: Obtain estimates of trade costs and trade

Xij,t = exp[πi,t + χj,t + µij + η1 FTAij,t + η2 ESi,t × INTLij ] ×

This step will deliver estimates of time-invariant bilateral

NOTE: The estimates of the trade costs can be constructed

Careful attention should be paid to any normalizations used

I Step 1.b: Recover Additional Parameters and

I Step 1.b: Recover Additional Parameters and

NOTE: This step is optional because the model can be

I Step 1.c: Construct Baseline Indexes.

I As well as any other indexes of interest, e.g Real GDP.

I Step 1.c: Construct Baseline Indexes.

I As well as any other indexes of interest, e.g Real GDP.

NOTE: If trade costs are calibrated, one needs to further

Alternatively, one may simulate the effects of a hypothetical

I Step 2: Define a Counterfactual Scenario.

Define the policy experiment by changing the definition

where: CFL stands for ‘counterfactual’; and ‘the hat’

I Step 3: Solve the Counterfactual Model.

I Step 3.a: Obtain ‘Conditional’ GE Effects. The ‘conditional’ (for

I Step 3.b: Obtain ‘Full Endowment’ GE Effects. This step

General Equilibrium response to trade policy changes.

I Step 4: Collect, Construct and Report Indexes of Interest.

Collect, and report indexes of interest:

I Step 5: Construct Confidence Intervals.

Generate sufficient number of sets of bootstrapped gravity

sample INDd , IND d , ..., IND .

Xij,t = exp[πi,t + χj,t + µij + η1 FTAij,t + η2 ESi,t × INTLij ] ×

Xij,t = exp[πi,t + χj,t + Tij,t β] + ij,t ,

Xij,t = exp[πj,t + χi,t + ] + εij,t .

Xij,t = exp[πj,t + χi,t + ] + εij,t .

I Use fixed effects as powerful (but dangerous!) weapons to get to trade

Xij,t = exp[πj,t + χi,t + ] + εij,t .

I Use fixed effects as powerful (but dangerous!) weapons to get to trade

Xij,t = exp[πj,t + χi,t + ] + εij,t .

I Use fixed effects as powerful (but dangerous!) weapons to get to trade

I But theoretical gravity, and corresponding counterfactual experiments,

Xij,t = exp[πj,t + χi,t + ] + εij,t .

I Use fixed effects as powerful (but dangerous!) weapons to get to trade

I But theoretical gravity, and corresponding counterfactual experiments,

Xij,t = exp[πj,t + χi,t + ] + εij,t .

I Use fixed effects as powerful (but dangerous!) weapons to get to trade

I But theoretical gravity, and corresponding counterfactual experiments,

I How much information do we miss when we move from estimating

Xij,t = exp[πj,t + χi,t + ] + εij,t .

Xij,t = exp[πi,t + χj,t + Tij,t β] + ij,t ,

Xij,t = exp[Tij,t β + πi,t + χj,t ] × ij,t ,

Xij,t = exp[Tij,t β + πi,t + χj,t ] × ij,t ,

Xij,t = exp[Tij,t β̄ + πi,t + χj,t ] × ij,t .

Xij,t = exp[T̄ij,t + πi,t + χj,t ] × ij,t .

Xij,t = exp[T̃ij,t + πi,t + χj,t ] × ij,t .