Gold Standard Gravity
This paper provides striking confirmation of the restrictions of the structural gravity model of trade. Structural forces predicted by theory explain 95% of the variation of the fixed effects used to control for them in the recent gravity literature, fixed effects that in principle could reflect other forces. This validation opens avenues to inferring unobserved sectoral activity and multilateral resistance variables by equating fixed effects with structural gravity counterparts. Our findings also provide important validation of a host of general equilibrium comparative static exercises based on the structural gravity model.
A much earlier version of a portion of this work was presented at the NBER ITI meetings, Spring 2010 and the Venice Trade Costs conference, June 2010. We thank participants for helpful comments, especially Dave Donaldson, Keith Head and Michael Waugh. We also thank Arthur Lewbel for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.