On the role of domestic trade flows for estimating the gravity model of trade

Abstract

The gravity equation is the workhorse model of trade. Despite solid theoretical foundations and clear gains from theory-consistent policy analysis, there are still gaps between gravity theory and empirics. This paper focuses on domestic trade flows, and I argue that there are significant benefits from adhering to theory by estimating gravity equations with domestic (in addition to international) trade flows. I review the related literature and synthesize 15 arguments for using domestic trade flows in gravity estimations. The analysis reveals the need for further theory contributions and new data developments, and points to opportunities for more policy applications.

Trade Agreements in South Asia: Towards a Successful Story in the Developing World

“…This comes from the fact that trade agreements divert some domestic flows toward international trade. This is an intuitive result, already seen in the literature (Yotov, 2022b),…”

“…where X k ij,t denotes the value of exports from origin country i to destination country j in sector k. X k ij,t includes domestic trade flows X k ii,t , necessary to link the gravity theory presented above and this empirical part. Yotov (2022b) reviews the related literature on this issue and argues that there are significant benefits from adhering to theory by estimating gravity equations with domestic (in addition to international) trade flows. Among these benefits, the most important for this paper is that the use of domestic trade flows allows for the identification of the trade-diversion effects of bilateral trade policies (Dai et al, 2014).…”

“…Among the recommendations in the literature to properly capture a trade agreement's effect, the inclusion of domestic trade flows is one of the priorities. Yotov (2022b) review the related literature on this issue and argues that there are significant benefits from adhering to theory by estimating gravity equations with domestic (in addition to international) trade flows. I make use of domestic trade flows to carry out theory-consistent policy analysis, linking the gravity theory and the empirical parts.…”

Los fundamentos conceptuales del modelo gravitacional de comercio: una revisión de la literatura

“…En consecuencia, propuso, para medir los efectos de la distancia respecto de los costos, la inclusión del comercio intrapaís, hallando evidencia a favor de la reducción de los costos internacionales con relación a los internos, en el contexto de la globalización económica. Estudios posteriores ratifican esta evidencia (Agnosteva et al, 2019;Campos et al, 2021) y rediscuten las implicancias de utilizar datos de comercio doméstico (Yotov, 2022).…”

Deep Trade Agreements and FDI in Partial and General Equilibrium: A Structural Estimation Framework

“…Guided by the theoretical model of Anderson et al (2019), 3 we specify two estimating gravity equationsone for trade and one for FDI, which are (i) consistent with and representative of a large number studies that quantify the impact of various determinants on FDI (e.g., Eicher et al, 2012;Blonigen and Piger, 2014;Kox and Rojas-Romagosa, 2020;Laget et al, 2021), and (ii) capitalize on the latest developments in the trade gravity literature (e.g., Head and Mayer, 2014;Yotov et al, 2016). Specically, we rely on the Poisson Pseudo-Maximum-Likelihood estimator to account for potential heteroskedasticity in the bilateral trade and FDI data and to take advantage of the information in the zero trade and FDI ows (cf.…”