Working Paper: CEPR ID: DP2987
Authors: Jacques Melitz
Abstract: This Paper reports on four basic results of tests of the standard gravity equation. First, geography can serve to reflect comparative advantage as well as transportation costs. Second, the effect of distance on bilateral trade is mostly a substitution effect between closer and more distant trade partners rather than a scale effect on total foreign trade. Third, special political relationships, such as free trade agreements, former colonial attachments, and currency union, do not produce any trade diversion in the aggregate, but increase trade with outsiders as well as among the parties to the relationship. Fourth, Rose?s surprisingly high estimate of the impact of currency union on trade stems partly from a selection bias, but even following a correction for this bias, the estimate remains high.
Keywords: bilateral trade; free trade area; geography; gravity; monetary union; trade creation; trade diversion
JEL Codes: F10; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Geographical distance (R12) | Trade (F19) |
| Distance (R12) | Trade with closer partners (F10) |
| Distance (R12) | Trade with more distant partners (F10) |
| Special political relationships (F50) | Increase trade among parties involved (F10) |
| Special political relationships (F50) | Increase trade with outsiders (F10) |
| Currency union (F36) | Trade (F19) |
| Selection bias (C52) | Impact of currency union on trade (F36) |