DP12521 Classical or Gravity? Which trade model best matches the UK facts?

Author(s): Patrick Minford, Yongdeng Xu
Publication Date: December 2017
Keyword(s): Bootstrap, classical trade model, gravity model, indirect inference, UK trade
JEL(s): F10, F14, F16, F17
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12521

We examine the empirical evidence bearing on whether UK trade is governed by a Classical model or by a Gravity model, using annual data from 1965 to 2015 and the method of Indirect Inference which has very large power in this application. The Gravity model here differs from the Classical model in assuming imperfect competition and a positive effect of total trade on productivity. We found that the Classical model passed the test comfortably, and that the Gravity model also passed it but at a rather lower level of probability, though as the test power was raised it was rejected. The two models' policy implications are similar.