DP9125 International Trade without CES: Estimating Translog Gravity

Author(s): Dennis Novy
Publication Date: September 2012
Keyword(s): Distance, Gravity, Import Share, Trade Cost Elasticity, Trade Costs, Translog
JEL(s): F11, F12, F15
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9125

This paper derives a micro-founded gravity equation based on a translog demand system that allows for flexible substitution patterns across goods. In contrast to the standard CES-based gravity equation, translog gravity generates an endogenous trade cost elasticity. Trade is more sensitive to trade costs if the exporting country only provides a small share of the destination country's imports. As a result, trade costs have a heterogeneous impact across country pairs, with some trade flows predicted to be zero. I test the translog gravity equation and find empirical evidence that is in many ways consistent with its predictions.