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5 Gravity
5 Gravity
2 3
Understanding the impact of distance and economy size on trade using the gravity model Apply the gravity model for the cases of FDI, and migration See how people use the gravity model to evaluate economic policy issues
The Origin of the Gravity Equation Newtons Law of Universal Gravitation (1687): The attractive force (Fij) between i and j
Fij G
MiM j Dij
2
Mi, Mj are the masses D is distance between two objects G is gravitational constant
Mi F D Mj
Fij G
Mi M j Dij
Fij is the flow from i to j Ms are measure of economic mass D is the distance
Take logs:
ln Fij R ln M i ln M j ln Dij ij
National customs data for a few countries Direct industry/shipping company info
Ocean shipping prices/air freight from trade journals (Hummels) Quotes from shipping standard container from Baltimore (Venables)
Magnitude
Wide dispersion of trade costs
US 3.8% value of imports (1994) Brazil 7.3% Paraguay 13.3%
Empirical Results
Shipping 40 container ($000)
Land locked dummy Distance (000km) Dist. Sea Dist. Land R2 0.32 3.45 (4.75) 0.38 (2.60) 0.19 (2.12) 1.38 (4.66) 0.47
R2 = 0.45
Empirical results
lnyi lnyj
lndistij
DUMMY R2
3. Introduce fixed-effects: two dummies one for the origin country and another one for the destination country: Di=1 if i is the exporter, 0 otherwise; Dj=1 if j is the importer, 0 otherwise; The two dummies are both equal to 1 only for cross-border trade observations. This implies: Di=(1-)lnPi and Dj=(1-)lnPj
Conclusions
Distance matters for trade Consistent with both new trade theory and old trade theory Theory has helped refine the gravity relationship Gravity can be used to test other hypotheses even if we dont know what drives gravity