Working Paper: NBER ID: w16672
Authors: Richard Baldwin; Daria Taglioni
Abstract: Trade is measured on a gross sales basis while GDP is measured on a net sales basis, i.e. value added. The rapid internationalisation of production in the last two decades has meant that gross trade flows are increasingly unrepresentative of the value added flows. This fact has important implications for the estimation of the gravity equation. We present empirical evidence that the standard gravity equation performs poorly by some measures when it is applied to bilateral flows where parts and components trade is important. We also provide a simple theoretical foundation for a modified gravity equation that is suited to explaining trade where international supply chains are important.
Keywords: gravity equation; bilateral trade; parts and components; international supply chains
JEL Codes: F1; F15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| standard gravity equation (C29) | poor estimation of bilateral trade flows (F14) |
| importance of parts trade increases (F10) | coefficient estimates on GDP decline (E20) |
| evolution of production networks (L23) | diminished explanatory power of GDP (E20) |
| wrong mass variable (C39) | bias in coefficient estimates (C51) |