Connected Trade Flows via Trade Costs: A Spatial Autoregressive Framework

Speaker: Dr Hanbat Jeong

Affiliation: Macquarie University

Location: Room 214, Chamberlain Building (#35), St Lucia Campus

Abstract: This paper proposes a new gravity specification grounded in countries’ network-leveraging features. Building on spatial autoregressive models, we endogenize trade costs as a function of a network of country proximities. The resulting specification induces interdependence among trade flows and pair-specific heterogeneity, and nests the conventional iceberg cost as a special case when countries do not leverage network connections. For estimation, we use PPML and develop robust inference accommodating heteroskedasticity and unknown error correlations. We also propose a fast algorithm for the large-dimensional network-multiplier transformation. Empirically, we find evidence of endogenous trade costs and substantially improved fit relative to the conventional gravity equation (up to 30%), implying pair-specific heterogeneity missed by existing models. Counterfactual analysis shows that a bilateral increase in trade costs generates sizable reallocations of import shares across many third countries once network interactions are accounted for.