James Anderson, Yoto Yotov, 20 December 2020

The gravity equation of international trade raises several empirical puzzles relating to the decreasing impact of distance, the declining trade-related costs of bilateral trade, and the estimation of trade elasticities. This column introduces a new, ‘short-run gravity’ model which simultaneously resolves all three of the above-mentioned puzzles. The model estimates a 14% decline in the distance elasticity and shows that capacity reallocation raised world manufacturing trade by 75% between 1998 and 2006. Finally, an estimated structural parameter implies that the short-tun trade elasticity is about one-fourth of its long-run counterpart. 

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