September 17, 2008

Gravity with gravitas: comment

In GRAVITY WITH GRAVITAS: A SOLUTION TO THE BORDER PUZZLE, Anderson and Van Wincoop (2003) estimate what trade between US states and Canadian provinces would have been if the border between Canada and the United States had not existed.

They showed that computing the border effect requires solving a non-linear system of multilateral price indexes. This note shows that the non-linear system can be solved analytically, such that a numerical approximation is no longer needed. The exact solution yields a reduced-form log-linear gravity equation that can be estimated using standard econometric techniques.

After estimation, the calculation of treatment effects like the border effect is straightforward. Using the same data and assumptions, I find that the border effect for Canada is half as large as reported by Anderson and Van Wincoop.

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