DP5850 Gravity for Dummies and Dummies for Gravity Equations

Author(s): Richard Baldwin, Daria Taglioni
Publication Date: September 2006
Keyword(s): country dummies, gravity equation, pair dummies
JEL(s): F10, F33, F4
Programme Areas: International Macroeconomics, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5850

This paper provides a minimalist derivation of the gravity equation and uses it to identify three common errors in the literature, what we call the gold, silver and bronze medal errors. The paper provides estimates of the size of the biases taking the currency union trade effect as an example. We generalize Anderson-Van Wincoop?s multilateral trade resistance factor (which only works with cross section data) to allow for panel data and then show that it can be dealt with using time-varying country dummies with omitted determinants of bilateral trade being dealt with by time-invariant pair dummies.