Gravity at 60: A celebration of the workhorse model of trade

From a VoxEU post by Yoto Yotov:

This year marks the 60th anniversary of the workhorse model of trade – the gravity equation. This column celebrates the anniversary by addressing some misconceptions about gravity and by tracing its evolution from an intuitive a-theoretical application to an estimating computable general equilibrium model that can be nested in more complex frameworks.

This year marks the 60th anniversary of the workhorse model of trade – the gravity equation (Tinbergen1962). Gravity is a ‘celebrity’ among economic models; it has been applied and extended in thousands of papers by trade economists, colleagues from other fields, and policy practitioners. Moreover, as noted by the brilliant late Peter Neary, the gravity equation is probably the only econometric model that has been featured on the front page of the Financial Times (on 19 April 2016). 

Unfortunately, and as sometimes happens to celebrities, the gravity model is misspecified (misunderstood) by the press. More worrisome, we often see gravity applications in academic papers and policy reports that are not consistent with theory and/or do not take into account major developments in the empirical gravity literature. As a result, the estimates in such papers could be severely biased and their policy recommendations could be misleading. Moreover, while it is well understood that trade theory and trade-policy analysis should be set in general equilibrium (GE), there is still a division and scepticism among academics and trade-policy practitioners about the usefulness of the gravity as a Computable GE (CGE) framework for counterfactual projections. A prominent example, which motivated the inclusion of the gravity equation in the Financial Times, is the debate among UK economists over gravity-based projections of the Brexit effects.

To celebrate gravity’s anniversary and address some misconceptions about the gravity model, in a new paper (Yotov 2022) I trace its evolution, as depicted in Figure 1, from a naive application to an ‘estimating CGE’ (E-CGE) model that can be nested in more complex frameworks.”

Continue reading here.

Posted by at 8:27 AM

Labels: Macro Demystified


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