ARTNeT Capacity Building Workshop for Trade Research: “Behind the Border” Gravity Modeling Bangkok, 15-19 December 2008 Ben Shepherd Niehaus Center, Princeton University; GEM, Sciences Po [email protected]; [email protected]

Introduction This workshop aims to provide participants with the following: 1. A solid understanding of the gravity model of bilateral trade, including its theoretical basis; 2. Practical skills in applying best practice gravity econometrics using Stata; 3. An appreciation of data and estimation issues involved in the application of gravity models to study trade costs and trade facilitation. In light of these objectives, most of the morning sessions will be organized around presentations by the trainer based on the existing literature. Most afternoon sessions will focus on “hands on” applications in which participants will be invited to explore concrete applications using real world data.

Monday, 15 December Session 1 (9:15-10:30) • Introduction to the workshop and its objectives; overview of methods and approach. • Presentation of the “basic” gravity model and brief discussion of some empirical applications. Session 2 (10:45-12:00) • Estimating a basic gravity model by ordinary least squares (OLS): – Estimation; – Testing simple and compound hypotheses; – Diagnostic tests; – Presentation and interpretation of results. Session 3 (13:00-14:30) z Introduction to Stata: – Structure and setup; – Online resources. z Using Stata to set up a gravity dataset: – Data manipulation: importing, merging, sorting, etc. – Exploratory data analysis: summary statistics, correlations, graphs, etc. Session 4 (14:45-16:00) • Using Stata to estimate a gravity model: – OLS regression, hypothesis testing, and diagnostic tests; – Tricks of the trade: do files, logs, and formatting output.

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Tuesday, 16 December Session 1 (8:30-10:30) z Weaknesses in the basic gravity model, and relative costs/prices; z The theoretical gravity model and “multilateral resistance”. Session 2 (10:45-12:00) • Estimating gravity models with multilateral resistance terms: – Dummy variables; – Taylor series approximations; – Differencing; – Nonlinear methods. Session 3 (13:00-14:30) • Using Stata to estimate OLS models with large numbers of dummy variables: – Direct estimation; – areg, absorb; – xtreg, fe. Session 4 (14:45-16:00) • Using Stata to calculate approximate multilateral resistance terms; • Estimation of the Taylor series gravity model; • Comparison of results from the basic, dummy variable, and Taylor series models.

Wednesday, 17 December Session 1 (8:30-10:30) • The gravity model as a panel data problem: multiple countries and multiple sectors; • Fixed effects estimator; • Random effects estimator; • Testing for fixed vs. random effects; Session 2 (10:45-12:00) • Difficulties with multi-sector gravity modeling, and how to deal with them: – Data variation, levels of analysis, and clustering of errors; – Cross-sectoral heterogeneity; Session 3 (13:00-14:30) • Setting up and working with large datasets in Stata. • Using Stata to estimate fixed and random effects models, and interpreting results; • Running the Hausman test in Stata. Session 4 (14:45-16:00) • Empirical applications on trade costs and trade facilitation in Asia: – Participant presentation (Mr. P. De); – Participant presentation 2 (Ms. J. Weerahewa); 2

Thursday, 18 December Session 1 (8:30-10:30) • Endogeneity and its consequences. • Dealing with endogeneity: – Instrumental variables (IV) estimation; – Diagnostic testing: instrument relevance; exogeneity and excludability; dependent variable endogeneity. Session 2 (10:45-12:00) • Estimating and testing IV models in Stata: ivreg, ivreg2, xtivreg, and xtivreg2. Session 3 (13:00-14:30) • Zero trade flows and their consequences. • Dealing with zero flows: – Ad hoc solutions; – Poisson PPML estimator; – Sample selection models. Session 4 (14:45-16:00) • Estimating PPML and sample selection models in Stata.

Friday, 19 December Session 1 (8:30-10:30) • Counterfactual simulations using gravity models. • The importance of general equilibrium, and the limits of fixed effects. Session 2 (10:45-12:00) • Running gravity counterfactuals in Stata. Session 3 (13:00-14:30) • Summing up and consolidation: best practice gravity modeling. • Additional techniques, alternatives, and ongoing research. Session 4 (14:45-16:00) • Brainstorming session on new applications of gravity models in Asia and the Pacific, focusing on trade costs and trade facilitation. • Conclusion.

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Suggested Reading

Statistics and Econometrics Participants are encouraged to review the basics of multivariate statistics and regression prior to the workshop. Any undergraduate econometrics text will cover the appropriate material. Three of the most commonly used are: • Stock & Watson, Introduction to Econometrics • Gujarati, Basic Econometrics • Wooldridge, Introductory Econometrics. An excellent graduate text is Wooldridge’s Econometric Analysis of Cross Section and Panel Data.

Using Stata There are numerous freely available guides to Stata on the internet. For participants who may be relatively unfamiliar with Stata, it would be useful to look through one of these prior to the workshop. Some of the better ones are: • http://personal.lse.ac.uk/MCMAHONM/stata/BOE_stata_notes%20-%20June%202008.pdf • http://www.ats.ucla.edu/stat/Stata/notes3/ • http://ksghome.harvard.edu/~pnorris/STM103%20Spring2008/Updated%20Shared%20dataset/Intr oductory%20Guide%20to%20using%20Stata.pdf

Monday, 15 December • • • •

Anderson, James, and Eric Van Wincoop, 2004, “Trade Costs”, Journal of Economic Literature, 42(3), 691-751, http://www.hss.caltech.edu/~camerer/SS280/TradeCosts.pdf. Head, Keith, 2000, “Gravity for Beginners”, http://www.duke.edu/~meh13/gravity.pdf. Chapter 5 in Feenstra, Robert, Advanced International Trade, http://www.unige.ch/ses/ecopo/staff/thoenig/chap5_Feenstra.pdf. Some examples of gravity modeling applied to trade costs and facilitation: – Djankov, Simeon, Caroline Freund, and Cong S. Pham, Forthcoming, “Trading on Time”, Review of Economics and Statistics, http://www.doingbusiness.org/Documents/TradingOnTime_APR08.pdf; – Persson, Maria, 2007, “Trade Facilitation and the EU-ACP Economic Partnership Agreements”, Journal of Economic Integration, 23(3), 518-546, http://www.nek.lu.se/nekmpe/Trade%20Facilitation%20and%20EPAs.pdf. – Wilson, John S., Catherine L. Mann, and Tsunehiro Otsuki, 2005, “Assessing the Benefits of Trade Facilitation: A Global Perspective”, The World Economy, 28(6), 841-871.

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Tuesday, 16 December and Wednesday, 17 December • •

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Anderson, James, and Eric Van Wincoop, 2003, “Gravity with Gravitas: A Solution to the Border Puzzle”, American Economic Review, 93(1), 170-192, http://www2.bc.edu/~anderson/BorderEffects.pdf. Baldwin, Richard E., and Daria Taglioni, 2007, “Trade Effects of the Euro: A Comparison of Estimators”, Journal of Economic Integration, 22(4), 780-818, http://hei.unige.ch/~baldwin/AcademicPapers/AcademicPaperFiles/NBERWPs/Gravity%20Dummi es.pdf. Baier, Scott L., and Jeffrey H. Bergstrand, 2007, “Bonus Vetus OLS: A Simple Method for Approximating International Trade-Cost Effects Using the Gravity Equation”, http://www.nd.edu/~jbergstr/Working_Papers/BVOLSOctober2007.pdf.

Thursday, 18 December •

Helpman, Elhanan, Marc Melitz, and Yona Rubinstein, 2008, “Estimating Trade Flows: Trading Partners and Trading Volumes”, Quarterly Journal of Economics, 123(2), 441-487, http://www.princeton.edu/~mmelitz/papers/EstimatingTradeFlows_QJE.pdf. • Santos Silva, Joao M.C., and Silvana Tenreyro, 2006, “The Log of Gravity”, Review of Economics and Statistics, 88(4), 641-658, http://cep.lse.ac.uk/pubs/download/dp0701.pdf. Note: These papers are very technical. For the purposes of this workshop, there is no need to worry too much about the mathematical details. We are interested in their identification of the zero flow problem, the difficulties it poses for estimation, and the solutions suggested.

Friday, 19 December • • •

Anderson, James, and Eric Van Wincoop, 2003, “Gravity with Gravitas: A Solution to the Border Puzzle”, American Economic Review, 93(1), 170-192, http://www2.bc.edu/~anderson/BorderEffects.pdf. Baier, Scott L., and Jeffrey H. Bergstrand, 2007, “Bonus Vetus OLS: A Simple Method for Approximating International Trade-Cost Effects Using the Gravity Equation”, http://www.nd.edu/~jbergstr/Working_Papers/BVOLSOctober2007.pdf. Chapter 5 in Feenstra, Robert, Advanced International Trade, http://www.unige.ch/ses/ecopo/staff/thoenig/chap5_Feenstra.pdf.

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