Re-visiting the Distance Coefficient in Gravity Model

TL;DR

This paper reexamines the distance coefficient in the gravity model of trade, confirming its stability over time and linking it to relative transportation costs, while also showing technological progress has reduced average trading costs.

Contribution

It provides empirical evidence that the distance coefficient measures relative costs and remains stable over time, despite technological advances, and links it to oil price sensitivity.

Findings

Distance coefficient is stable from 1991-2006.

Technological progress reduces average trading costs.

Results are consistent across industries.

Abstract

This paper revisits the classic gravity model in international trade and reexamines the distance coefficient. As pointed out by Frankel (1997), this coefficient measures the relative unit transportation cost between short distance and long distance rather than the absolute level of average transportation cost. Our results confirm this point in the sense that the coefficient has been very stable between 1991-2006, despite the obvious technological progress taken place during this period. Moreover, by comparing the sensitivity of these coefficients to change in oil prices at short periods of time, in which technology remained unchanged, we conclude that the average technology has indeed reduced the average trading cost. The results are robust when we divide the aggregate international trades into different industries.