Trade Frictions and Welfare in the Gravity Model
In their investigation, the researchers addressed recent analysis of the model by James Anderson and Eric van Wincoop on structural econometric estimates. Balistreri and Hillberry focused on three predictions regarding welfare: the implied size of the transport sector; the price wedge imposed by distance and border related costs; and the degree of spatial variation in retail price indices. Through their examination, they find that the modelís quantitative predictions are at odds with available evidence on the resource costs of transportation and the geographic dispersion of prices. After assessing the modelís general equilibrium predictions, they conclude that the gravity model is unsuitable for welfare estimation analysis.
Additionally, Balistreri and Hillberry conclude that the theoretical model is too dependent on transport costs and their consequent behavior on consumer behavior. Under plausible parameterizations of the standard gravity model, they found that iceberg melt (the cost of transporting a good that uses up only some fraction of the good itself, rather than using any other resources) consumes over forty-five percent of output and transport markup is between fifty and eighty percent. Their tests of the model indicate large unobserved differences in the cost of living between the United States and Canada: Canadians bear a disproportionate share of distance and border costs and their consumer prices are more that twenty percent higher than in the United States.