Gravity without Apology: The Science of Elasticities, Distance, and Trade C´ eline Carr` ere Geneva and CEPR Monika Mr´ azov´ a Geneva and CEPR J. Peter Neary Oxford, CEPR and CESifo Royal Economic Society Annual Conference University of Warwick April 15, 2019 CMN (Geneva and Oxford) Gravity without Apology RES: April 15, 2019 1 / 80
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Gravity without Apology: The Science ofElasticities, Distance, and Trade
Celine Carrere
Geneva and CEPR
Monika Mrazova
Geneva and CEPR
J. Peter Neary
Oxford, CEPR and CESifo
Royal Economic Society Annual ConferenceUniversity of Warwick
April 15, 2019
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Introduction
Introduction: Gravity and International Trade
Gravity: The value of trade declines with distance
One of the great successes of modern economics
Gravity in trade is both fact and theory– Like evolution: Gould (1981)
Though this is not widely known by economists outside trade
And “anti-gravity” continues to have popular appeal
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Introduction
Gravity in the News05/03/2019, 18+12Financial Times (UK) | Tuesday, April 19, 2016 | Front Page | 1
Page 1 of 1http://digital.olivesoftware.com/Olive/APA/FinancialTimesUK/Pri…sue_date=Tuesday%2C%20April%2019%2C%202016§ion=Front%20Page
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Introduction
Anti-Gravity
“Today, we stand on the verge of an unprecedented ability to liberate global tradefor the benefit of our whole planet with technological advances dissolving away thebarriers of time and distance. It is potentially the beginning of what I might call ‘postgeography trading world’ where we are much less restricted in having to find partnerswho are physically close to us.”
– Liam Fox, UK Minister for International Trade, Sept. 2016
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Introduction
This Lecture
Review the evidence for gravity
Introduce some simple ways of understanding CES gravity
Note some problems with CES
Sketch some alternatives
Background: Brexit ...
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Introduction
Brexit: Not Just Economics
“I don’t think we’ll be poorer out [of the EU], but if you told memy family would have to eat grass I’d still have voted to leave.”
– anon.; quoted by Robert Shrimsley, Financial Times, Dec. 14, 2018
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Introduction
What they told us ...
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Introduction
What they didn’t tell us ...
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Introduction
Sincere, Strongly-Held Views – On Both Sides
“I don’t think we’ll be poorer out, but if you told me my familywould have to eat grass I’d still have voted to leave.”
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Introduction
Here: Focus on the Economics
“I don’t think we’ll be poorer out, but if you told me my familywould have to eat grass I’d still have voted to leave.”
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Introduction
Economics of Brexit
Many studies of the trade effects of Brexit
Predominantly using the gravity model
Dhingra et al. (2017), Sampson (2017)Brakman, Garretsen, and Kohl (2018)Mayer, Vicard, and Zignago (2019)
I ignore work on other economic aspects of Brexit
Davies and Studnicka (2018): Stock-market responseMcGrattan and Waddle (2018): Impact on foreign investmentAlabrese, Becker, Fetzer, and Novy (2019): Determinants of votingO’Rourke (2019): Historical context
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Introduction
Economics of Brexit: Professional Consensus
Professional consensus: Three Iron Laws of the Economics of Brexit
Focusing on trade in goods ...... ignoring transitional problems ...
... and macro policy responses
1 The only good Brexit is a dead Brexit
2 The harder the Brexit the higher the economic costs
3 Even a hard Brexit will not have “very” large costs
2% of GDP if soft, 6+% of GDP if hard
Compare: UK spent 7.26% of GDP on NHS in 2016/17
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Introduction
Background
Carrere, C., M. Mrazova, and J. P. Neary (2019): “Subconvex Gravity,” inpreparation.
Mrazova, M., and J. P. Neary (2017): “Not so Demanding: Demand Structureand Firm Behavior,” American Economic Review, 107(12), 3835–3874.
Mrazova, M., and J. P. Neary (2019): “Selection Effects with HeterogeneousFirms,” Journal of the European Economic Association, forthcoming.
Mrazova, M., and J. P. Neary (2019): “IO for Export(s),” Working Paper No.868, Department of Economics, University of Oxford.
Maggi, G., M. Mrazova, and J. P. Neary (2018): “Choked by Red Tape? The
Political Economy of Wasteful Trade Barriers,” CEPR Discussion Paper No. 12985.
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Introduction
Outline
1 Gravity as Fact
2 Gravity as Theory
3 Gravity Anomalies
4 Subconvex Gravity
5 Conclusion
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Gravity as Fact
Outline
1 Gravity as Fact
2 Gravity as Theory
3 Gravity Anomalies
4 Subconvex Gravity
5 Conclusion
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Gravity as Fact
The Gravity Equation: A Universal Tendency
Overwhelming professional consensus that distance matters for trade
Head and Mayer (2014): review of 159 papers
Average preferred estimate of distance elasticity: −1.1
S.D. 0.41; median −1.14
Not just geographical distance matters:
Common language, legal system, colonial origins, FTA membership,etc.
Results below for distance elasticity of 2017 UK exports in line withthe literature:
−0.752 (0.098): OLS, simple regression, n = 181−1.441 (0.029): OLS, full controls, n = 23, 251−0.977 (0.021): PPML, full controls, n = 42, 230
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Gravity as Fact
Gravity: Not Just for Trade in Goods
Distance also matters (though less so on average) for:
Services trade: Kimura and Lee (2006)
FDI: Kleinert and Toubal (2010), Keller and Yeaple (2013)
Equities: Portes and Rey (2005)
eBay: Lendle, Olarreaga, Schropp, and Vezina (2016)
Google: Cowgill and Dorobantu (2012)
And the distance coefficient for goods trade has not fallen over time
“The Mystery of the Missing Globalization”!
But: Not a mystery
Distance is relative
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* Significantly different at 5% leveln.s. Not significant
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Subconvex Gravity
Subconvex Gravity: Evidence and Implications
Persuasive Evidence for Subconvexity
Distance coefficient significantly decreasing (in absolute value) in trade
Replication needed ...
Implications for the Trade Balances Puzzle?
Bilateral balances now depend on distance
Provisional evidence confirming this
Implications for Brexit?
With subconvexity, elasticities are higher in smaller markets
Implications for estimated effects of Brexit unlikely to be major
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Conclusion
Outline
1 Gravity as Fact
2 Gravity as Theory
3 Gravity Anomalies
4 Subconvex Gravity
5 Conclusion
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Conclusion
Conclusion
Gravity as Fact
Overwhelming evidence that trade tends to fall with distance
Gravity as Theory
A simple general equilibrium systemNew analytic tools for understanding it
Gravity Anomalies
Constant Elasticity of Trade not the whole story
Subconvex gravity a promising direction
Unlikely to change the Three Iron Laws of the Economics of Brexit
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Conclusion
What They Should Have Told Us ...
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Conclusion
Thanks and Acknowledgements*
Thank you for listening. Comments welcome!
* Some of the research on which this lecture draws received funding from the EuropeanResearch Council under the European Union’s Seventh Framework Programme(FP7/2007-2013), ERC grant agreement no. 295669.
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Supplementary Material Details: Effects of Shocks to Goods-Market-Equilibrium
Details: Goods-Market Equilibrium
Equilibrium in market for YB: Back to text
XB = εBB pB + εBE pE + εBtE tBE + εBtA tBA = 0
where the elasticities of excess demand for YB are:
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Supplementary Material Gravity Anomalies 1: Micro Evidence
Gravity Anomalies 1: Micro Evidence
Back to text
CES demands imply constant markups and 100% pass-through:
p
c=
σ
σ − 1and
d log p
d log c= 1
But: Mounting empirical evidence to the contrary
Mark-ups differ a lot across firms, even in narrowly-defined industries.
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Supplementary Material Gravity Anomalies 1: Micro Evidence
Empirical Evidence on Markups I
PRICES, MARKUPS, AND TRADE REFORM 493
FIGURE 4.—Distribution of marginal costs and markups in 1989 and 1997. Sample only in-cludes firm–product pairs present in 1989 and 1997. Outliers above and below the 3rd and 97thpercentiles are trimmed.
higher markups. The results indicate that firms offset the beneficial cost reduc-tions from improved access to imported inputs by raising markups. The overalleffect, taking into account the average declines in input and output tariffs be-tween 1989 and 1997, is that markups, on average, increased by 12.6 percent.This increase offsets almost half of the average decline in marginal costs, andas a result, the overall effect of the trade reform on prices is moderated.52
Although tempting, it is misleading to draw conclusions about the pro-competitive effects of the trade reform from the markup regressions in Col-umn 3 of Table IX. The reason is that one needs to control for the impacts of
52These results are robust to controlling India’s de-licensing policy reform; see Table A.I in theSupplemental Material.
From: de Loecker, Goldberg, Khandelwal and Pavcnik (2016)
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Supplementary Material Gravity Anomalies 1: Micro Evidence
Empirical Evidence on Markups II
From: Lamorgese, Linarello and Warzynski (2014)
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Supplementary Material Gravity Anomalies 2: Cross-Market Heterogeneity
Gravity Anomalies 2: Cross-Market Heterogeneity
Back to text
CES-based models predict the same elasticity of import demand in allmarkets.
Macro elasticity, not micro elasticity facing firms
By contrast, Novy (2013) finds that elasticities are systematically lower inlarger and closer markets.
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References
References I
Alabrese, E., S. O. Becker, T. Fetzer, and D. Novy (2019): “Who Voted forBrexit? Individual and Regional Data Combined,” European Journal of PoliticalEconomy, 56, 132–150.
Allen, T., C. Arkolakis, and Y. Takahashi (2019): “Universal Gravity,” Journalof Political Economy, forthcoming.
Anderson, J. E. (1979): “A Theoretical Foundation for the Gravity Equation,”American Economic Review, 69(1), 106–116.
Anderson, J. E., and E. van Wincoop (2003): “Gravity with Gravitas: A Solutionto the Border Puzzle,” American Economic Review, 93(1), 170–192.
Arkolakis, C., A. Costinot, and A. Rodrıguez-Clare (2012): “New TradeModels, Same Old Gains?,” American Economic Review, 102(1), 94–130.
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References
References II
Baqaee, D. R., and E. Farhi (2017): “Productivity and Misallocation in GeneralEquilibrium,” CEPR Discussion Paper No. 12447.
Bergstrand, J. H. (1985): “The Gravity Equation in International Trade: SomeMicroeconomic Foundations and Empirical Evidence,” Review of Economics andStatistics, 67(3), 474–481.
Brakman, S., H. Garretsen, and T. Kohl (2018): “Consequences of Brexit andoptions for a ‘Global Britain’,” Papers in Regional Science, 97(1), 55–72.
Cairncross, F. (1997): The Death of Distance. London: Texere Publishing.
Carrere, C., M. Mrazova, and J. P. Neary (2019): “Subconvex Gravity,” inpreparation.
Chaney, T. (2008): “Distorted Gravity: The Intensive and Extensive Margins ofInternational Trade,” American Economic Review, 98(4), 1707–1721.
Cowgill, B., and C. Dorobantu (2012): “Gravity and Borders in OnlineCommerce: Results from Google,” mimeo., Department of Economics, University ofOxford.
Davies, R. B., and Z. Studnicka (2018): “The Heterogeneous Impact of Brexit:Early Indications from the FTSE,” European Economic Review, 110, 1–17.
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References
References III
Davis, D. R., and D. E. Weinstein (2002): “The Mystery of the Excess Trade(Balances),” American Economic Review, 92(2), 170–174.
De Loecker, J., P. K. Goldberg, A. K. Khandelwal, and N. Pavcnik (2016):“Prices, Markups and Trade Reform,” Econometrica, 84(2), 445–510.
Dhingra, S., H. Huang, G. Ottaviano, J. Paulo Pessoa, T. Sampson, andJ. Van Reenen (2017): “The Costs and Benefits of Leaving the EU: Trade Effects,”Economic Policy, 32(92), 651–705.
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Eaton, J., S. Kortum, and S. Sotelo (2013): “International Trade: Linking Microand Macro,” in D. Acemoglu, M. Arellano, and E. Dekel (eds.): Advances inEconomics and Econometrics Tenth World Congress, Volume II: Applied Economics,Cambridge University Press.
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References
References IV
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Jones, R. W., and J. A. Scheinkman (1977): “The Relevance of the Two-SectorProduction Model in Trade Theory,” Journal of Political Economy, 85(5), 909–935.
Keller, W., and S. R. Yeaple (2013): “The Gravity of Knowledge,” AmericanEconomic Review, 103(4), 1414–1444.
Kimura, F., and H.-H. Lee (2006): “The Gravity Equation in International Trade inServices,” Review of World Economics, 142(1), 92–121.
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References
References V
Kleinert, J., and F. Toubal (2010): “Gravity for FDI,” Review of InternationalEconomics, 18(1), 1–13.
Krugman, P. (1980): “Scale Economies, Product Differentiation, and the Pattern ofTrade,” American Economic Review, 70(5), 950–959.
Krugman, P. R. (1979): “Increasing Returns, Monopolistic Competition, andInternational Trade,” Journal of International Economics, 9(4), 469–479.
Lamorgese, A., A. Linarello, and F. Warzynski (2014): “Free TradeAgreements and Firm-Product Markups in Chilean Manufacturing,” Discussion paper,Aarhus University.
Lendle, A., M. Olarreaga, S. Schropp, and P.-L. Vezina (2016): “There GoesGravity: eBay and the Death of Distance,” Economic Journal, 126(591), 406–441.
Machado, J. A., and J. Santos Silva (2019): “Quantiles via Moments,” Journalof Econometrics (forthcoming).
Maggi, G., M. Mrazova, and J. P. Neary (2018): “Choked by Red Tape? ThePolitical Economy of Wasteful Trade Barriers,” CEPR Discussion Paper No. 12985.
Mayer, T., V. Vicard, and S. Zignago (2019): “The Cost of Non-Europe,Revisited,” Economic Policy, forthcoming.
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References
References VI
McGrattan, E. R., and A. Waddle (2018): “The Impact of Brexit on ForeignInvestment and Production,” Federal Reserve Bank of Minneapolis, ResearchDepartment Staff Report 542.
Melitz, M. J. (2003): “The Impact of Trade on Intra-Industry Reallocations andAggregate Industry Productivity,” Econometrica, 71(6), 1695–1725.
Mrazova, M., and J. P. Neary (2017): “Not So Demanding: Demand Structureand Firm Behavior,” American Economic Review, 107(12), 3835–3874.
(2019a): “IO for Export(s),” Working Paper No. 868, Department ofEconomics, University of Oxford.
(2019b): “Selection Effects with Heterogeneous Firms,” Journal of theEuropean Economic Association, forthcoming.
Novy, D. (2013): “International Trade without CES: Estimating Translog Gravity,”Journal of International Economics, 89(2), 271–282.
O’Rourke, K. (2019): A Short History of Brexit: From Brentry to Backstop. London:Pelican Books.
Portes, R., and H. Rey (2005): “The Determinants of Cross-Border Equity Flows,”Journal of International Economics, 65(2), 269–296.
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References
References VII
Sampson, T. (2017): “Brexit: The Economics of International Disintegration,” Journalof Economic Perspectives, 31(4), 163–84.
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