DP9125 | International Trade without CES: Estimating Translog Gravity

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09/09/2012

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Abstract

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.