Download ESCAP-World Bank Trade Cost Database - Implication for Asia-Pacific Connectivity WTO/ESCAP 10

WTO/ESCAP 10th ARTNeT Capacity Building Workshop for Trade Research
ESCAP-World Bank Trade Cost Database Implication for Asia-Pacific Connectivity
Presented by
Yann Duval, Chief
Chorthip Utoktham, Consultant
Trade Facilitation Unit, Trade & Investment Division, UNESCAP
Based on a Joint paper with Jean-François Arvis (WB) and
Ben Shepherd (Developing Trade Consultants)
(Trade Costs in the Developing World: 1995-2010)
1
16/06/2015
Outline
1.
Background & rationale for the database
2.
Trade costs in the ESCAP-WB Database: Definition
3.
End result – the ESCAP-World Bank Trade Cost
Database
4.
Trade costs in developing countries: Main findings
5.
Explaining trade costs
6.
Conclusion and policy implications
7.
Other Applications / Extensions of the Database
2
1. Background & Rationale for the Database
Regional/global trade and production networks as a key engine
of development
Trade Facilitation [TF] (efficient trade procedures and low
trade costs) essential to enable firms to participate
Intraregional (South-South) trade important for A-P countries
to continue growing at a time when developed markets
slowing/shrinking
Some cross-country indicators of TF and trade costs available
(e.g., WB Doing Business indicators) but none allowing for
measuring bilateral/intra-regional trade costs
Development of a bilateral trade cost database to provide a
systematic and standardized way to evaluate trade costs in
developing countries





3
2. ESCAP-WB Trade Cost: Definition


Based on the comprehensive trade costs measure proposed by
Jacks, Meissner and Novy (2009)

Measure derived from the theory-consistent gravity equation, i.e., ratio based
essentially on Bilateral Trade data and Gross Output data

 “objective” measure of costs
Captures all additional costs involved in trading goods bilaterally relative
to those involved in trading goods domestically. It includes:



International shipping and logistics costs
Tariff and non-tariff costs, including indirect and direct costs associated with
trade procedures and regulations
Costs from differences in language, culture, currencies…
2. ESCAP-WB Trade Cost: Definition
Our measure of ad valorem trade costs:

1
2
Where
 tij t ji 
 X ii X jj 
 1  

 ij   ji  

X X 
t
t
 ii jj 
 ij ji 
1
2  1
1

τij denotes geometric average trade costs between country i and country j

tij denotes international trade costs from country i to country j

tji denotes international trade costs from country j to country i

tii denotes intranational trade costs of country i

tjj denotes intranational trade costs of country j

Xij denotes international trade flows from country i to country j

Xji denotes international trade flows from country j to country i

Xii denotes intranational trade of country i

Xjj denotes intranational trade of country j
σ denotes intra-sectoral elasticity of substitution (which is set = 8)

5
2. ESCAP-WB Trade Cost: Definition
Our measure of ad valorem trade costs:

1
2
 tij t ji 
 X ii X jj 
 1  

 ij   ji  

X X 
t
t
 ii jj 
 ij ji 
1
2  1
1
Intuition: keeping all else constant, a rise in the ratio of
international trade relative to domestic trade must be
associated with a fall in international trade costs relative to
domestic trade costs
Ad valorem ?  bilateral trade costs are expressed in % of the
value of goods (like tariffs generally are)
Important note: Change in the value of sigma can change the
absolute value of trade costs  better to look at trade cost
relative to each other



6
2. ESCAP-WB Trade Cost: Definition
Our measure of ad valorem trade costs:

1
2
 tij t ji 
 X ii X jj 
 1  

 ij   ji  

X X 
t
t
 ii jj 
 ij ji 
1
2  1
1
Note that:
 Our trade costs are always expressed in terms of international
relative to intra-national trade costs
 Our trade costs are the geometric average of trade costs in both
directions (country i to j and country j to i)

7
 This can makes the identification of policy effects challenging
Appendix – Data and Sources
To calculate trade costs between countries i and j, we need data on:





Exports from i to j
Exports from j to i
Production in country i that is also consumed there, in gross shipments
terms (not value added)
Production in country j that is also consumed there, in gross shipments
terms (not value added)
Getting the international trade data is straightforward:




WITS-UN Comtrade
Aggregate into two macro-sectors, manufacturing (ISIC D) and
agriculture (ISIC A and B) using a WITS concordance
Adjustment for re-exports using other sources for a small number of
countries
Getting the intra-national trade data is less straightforward

8
Appendix – Data and Sources
For some countries, data on domestic production in gross
shipments terms are available through the UN national
accounts system




Coverage is up to 124 countries
Conversion from Local Currency Units to USD using the WDI
GDP exchange rate
Calculation of intra-national trade as domestic production
less total exports to the rest of the world
For countries for which gross domestic production is not
available, we infer it from GDP

9
Appendix – Data and Sources

For those countries that lack domestic production in
gross shipments terms:





10
We take GDP data by ISIC aggregate from the WDIs,
supplemented by the UN national accounts system
GDP data cannot be used directly because they are in value
added not gross shipments terms (i.e., they net out
intermediate input use)
We therefore calculate average gross shipments to value added
ratios for the two ISIC aggregates for those countries where
we have both sets of data
We use those ratios to ―gross up‖ the value added data to
their estimated gross shipments equivalents
We then calculate intra-national trade as domestic production
less total exports to the rest of the world
3. End Result – the ESCAP-WB Trade
Cost Database



“All-inclusive” Bilateral trade costs for 178 countries
[Now >180]
For the period 1995-2010* [Now -2012]
Two macro-sectors covered



Agriculture
Manufacturing
Underlying data on international trade (Xij, Xji) are relatively easy to
come by, but data on intranational trade (Xii, Xjj) are more
complicated…

Intranational trade = Gross Output (from UN National Account statistics) –
export
*Linear interpolation applied to fill in missing trade costs observations
11


http://artnet.unescap.org/databases.html#first

http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?so
urce=escap-world-bank:-international-trade-costs
4. Main findings
All-inclusive international trade costs are at least one
order of magnitude (10 times) larger than tariffs
1.

Our ―all-inclusive‖ measures cover tariffs, NTMs of all types,
trade facilitation, connectivity, and logistics, as well as
geographical factors, and cultural/historical/institutional
factors—everything that drives a wedge between domestic and
international prices

14
Consistent with Anderson and Van Wincoop (2004), who provide a
guesstimate of 5% ad valorem for average rich country tariffs,
compared with 74% ad valorem for international trade costs
4. Main Findings
2.
Trade costs in developing countries are much higher
than in developed countries, and they are falling more
slowly
300
250
200
150
100
50
0
High income
15
Upper middle income
1996
Lower middle income
2009
Low income
4. Main findings
3.
Trade costs in agriculture are much higher than trade
costs in manufacturing in all income groups, and they
are basically static over time
400
350
300
250
200
150
100
50
0
High income
16
Upper middle income
1996
Lower middle income
2009
Low income
4. Main findings
4.
Differences in policy and geography/culture translate
into different levels of trade costs in different regions
300
250
200
150
100
50
0
1996
17
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
East Asia & Pacific
Europe & Central Asia
Latin America & Caribbean
Middle East & North Africa
South Asia
Sub-Saharan Africa
2008
2009
Intra- and extra-regional comprehensive trade costs in the
Asia-Pacific region (excluding tariff costs), 2008-2013
Region
ASEAN-4
East Asia-3
North and
Central Asia - 4
Pacific Islands
Developing Economies
SAARC-4
AUS-NZL
EU-3
USA
North
East Asiaand
ASEAN-4
3
Central
Asia - 4
76%
(9%)
75%
51%
(5%)
(-5%)
351%
177%
121%
(9%)
(-7%)
(9%)
175%
174%
368%
(-11%)
(-9%)
(34%)
128%
125%
282%
(2%)
(-0%)
(13%)
101%
89%
338%
(4%)
(-3%)
(-5%)
108%
85%
152%
(2%)
(-4%)
(-8%)
85%
63%
180%
(11%)
(-0%)
(2%)
Pacific
Islands
SAARC-4 AUS-NZL
Developing
Economies
133%
(-10%)
317%
(2%)
73%
(-22%)
211%
(-6%)
163%
(-11%)
Source: ESCAP-World Bank Trade Cost Database, updated June 2015. Available from
114%
(10%)
142%
(-1%)
114%
(3%)
109%
(6%)
54%
(1%)
109%
(0%)
100%
(4%)
18
Trade costs: http://artnet.unescap.org/databases.html#first
EU-3
43%
(-4%)
67%
(0%)
Bilateral comprehensive trade costs in the Asia-Pacific,
excluding tariff costs of selected economies with China and
United States (2008-2013)
19
4. Explaining trade costs

From a policy perspective, it is important to break trade
costs down into their component parts



Which sources of trade costs are the most important in terms
of determining the overall pattern observed across countries?
What sorts of policies would be most effective in lowering
trade costs and reducing the relative isolation of many low
income countries?
Econometric estimation becomes necessary at this point:
we use a model with trade cost variables to explain the
observed pattern of trade costs across countries
20
4. Explaining trade costs

Factors included in the trade cost model are:














Distance
Common border
Common language
Existence of a colonial relationship
Common colonial heritage
Once part of the same country
Tariffs
Membership of the same RTA
Exchange rate
Liner shipping connectivity (UNCTAD)
Air connectivity (Arvis and Shepherd)
Logistics Performance Index
Cost of starting a business
We estimate the models for a single year for all countries, in agriculture
and manufacturing sectors
21
4. Explaining trade costs (Beta coefficients*)
entry cost
LPI
ACI
LSCI
exchange rate
RTA
tariff
Agri
Mfg
same country
common colonizer
colony
common language (official)
common language (ethno)
common border
distance
-1
22
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
*the amount of increase in trade costs (measured in standard deviations) that is associated with
a one standard deviation increase in each independent variable
Trade Costs in Asia and the Pacific
Contribution of natural barriers, behind-the border facilitation and
trade-related practice to trade costs
Tariff Trade Costs
0-10%*
60-90%*
Policy-Related
Non-Tariff Trade Costs
Natural Trade Costs
(Geographical and Cultural Factors)
1%
Direct Behind- & At-the border Trade Costs
6-7%
Availability/use of ICT Services
6-7%
Business (Regulatory) Environment
16-18%
Maritime Connectivity/Services
52-57%
Other Trade Costs
•Indirect cost of trade procedure
•Currency fluctuation
•Other non-tariff barriers
10-30%*
* Illustrative based on casual observation of the data only. Natural trade costs for landlocked countries may be outside
the range shown for natural trade costs.
Conclusion & policy implications

Key findings:
1.
2.
3.
4.
5.
6.
24
All-inclusive trade costs more than an order of magnitude
higher than tariff rates
Trade costs in developing countries much higher than in
developed countries, and falling more slowly
Trade costs in agriculture much higher than trade costs in
manufacturing in all income groups, and static over time
Very different levels of trade costs in different developing
regions
Often cheaper for developing countries to trade with faraway developed countries than to trade with neighbors
From higher to lower trade costs in A-P: Central Asia 
South Asia Southeast Asia  East Asia (excluding Mongolia)
Conclusion and policy implications
Some





preliminary implications:
Streamlining trade procedures (narrow TF), maritime connectivity and
logistics most important policy areas for moving forward on trade costs
East Asia and the Pacific may provide an important stock of best practice
in the developing world when it comes to reducing trade costs
To successfully reduce trade costs, action necessary on a number of
fronts at once—a broad agenda is appropriate
Sectoral focus (on agriculture) of technical assistance/capacity building
on trade facilitation may be effective approach
Particular attention needed on reducing intra-regional trade costs
The
analysis of trade costs provide a useful starting point in engaging
with countries on their trading environment… other tools (microlevel) needed to identify actual bottlenecks and develop solutions

25
E.g., ESCAP-UNECE UNNExT Business Process Analysis Guide
Conclusion and policy implications

Way Forward:







26
Continuous updating of the database
Deepen analysis on agricultural trade cost
Explore ways to breakdown the ―all-inclusive‖ trade cost
measure into components (isolate the ―policy-related‖
component in particular)
Improve on the trade cost models to include more factors
Calculate trade costs at a more disaggregated level & add
service sector
Include more developing countries (particularly LDCs and
LLDCs in the database)
…
Arvis et. al (forthcoming): Trade costs in the Developing World
 Based on Arvis et. al (2012/13)
 Improvements made:
o Aggregation of bilateral trade costs into a single
consistent measure of trade costs for each
country
o Presentation of trade costs in index form rather
than in absolute term
o Use of “panel” data (2007, 2010 and 2012) rather
than one-year cross-sectional data
o(Air connectivity index removed)
27
Trade costs in Developing Countries
Arvis et al. (forthcoming)
9. Developing countries in some regions have been more successful than
others in reducing trade costs in relative term.
28
Outline
1.
Background & rationale for the database
2.
Trade costs in the ESCAP-WB Database: Definition
3.
End result – the ESCAP-World Bank Trade Cost
Database
4.
Trade costs in developing countries: Main findings
5.
Explaining trade costs
6.
Conclusion and policy implications
7.
Other Applications / Extensions of the Database
29
Value added trade costs in Goods and Services
(Duval, Saggu and Utoktham, May 2015)
A
Why Trade Costs in Value added?
B
Value Added Trade Costs: Definition
C
Value Added Trade Costs: Data Source
D
Trade costs in developing countries: Findings
E
.
Conclusion
F
http://www.unescap.org/resources/value-added-trade-costsgoods-and-services
Trade costs:
http://artnet.unescap.org
30
Why Trade Costs in Value Added? – Initiation
 Products are increasingly being ‘Made in the World’
rather than made in a specific country (WTO, 2015).
 What increasingly matters for growth and development
is not the volume or gross value of goods being traded,
but the value addition made as part of the trading
process.
 Trade costs calculated based on value added data
rather than gross data may provide a more relevant
indicator to develop trade and development strategies.
 [Create an alternative dataset covering more sectors]
Trade costs:
http://artnet.unescap.org
31
Value-Added Trade Costs: Definition
Our measure of ad valorem trade costs:
1
2
 tij t ji 
 X ii X jj 
 1  

 ij   ji  



t
t
X
X
ii
jj
ij
ji




1
2  1
1
 The interpretation is still the same as ones in Arvis et. al
(2013) where the trade costs are international trade costs
relative to intranational one
32
Value added trade costs : Data Source
•To calculate trade costs between countries i and j, we need data
on:
 Exports from i to j
 Exports from j to i
 Production in country i that is also consumed there, in
gross shipments terms (not value added)
 Production in country j that is also consumed there, in
gross shipments terms (not value added)
• Getting both international/intranational trade data is
straightforward:
 OECD-WTO Trade in Value Added database
 Data is available in both international and domestic
value added
 Data are categorized into 18 main sectors in ISIC Rev 3.
 Aggregate into 3 macro-sectors: agriculture,
manufacturing, and services
 56 countries are available in the dataset (22 non-OECD)
Trade costs:
http://artnet.unescap.org
33
VA Trade costs in developing countries: Findings
1. In absolute term, trade costs calculated using value added data
are lower than those calculated using gross trade and output data
Trade costs with China in the goods
sector, 2009
Trade costs:
http://artnet.unescap.org
34
VA Trade costs in developing countries: Findings
2. In relative term, Gross and VA trade costs give similar result.
Trade costs in goods sector are declining over time.
Trade costs:
http://artnet.unescap.org
35
VA Trade costs in developing countries: Findings
3. Value added trade costs tend to be higher in the services sector
compared to the goods sector.
Trade costs with China in the goods, services, transport and telecoms, and finance and
insurance sectors, 2009
36
VA Trade costs in developing countries: Findings
5. Lower value added trade costs is clearly associated with greater
participation in global value chains – in terms of greater exports of
intermediate goods.
37
Value-Added Trade Costs in goods & services: Conclusion
Key findings:
1. In absolute term, trade costs calculated using value added data are lower
than those calculated using gross trade and output data.
2. In relative term, trade costs in both approaches gives similar result. Trade
costs in goods sector are declining over time.
3. Value added trade costs tend to be higher in the services sector compared
to the goods sector. In contrast to sub-sector industries for goods trade
(e.g., agriculture vs. manufacturing), differences in value added trade costs
across services sub-sectors (e.g., transport and telecoms vs. finance and
insurance) also tend to be more limited.
4. East Asia–3 remains low in both gross shipment and value added term.
5. Lower value added trade costs is clearly associated with greater
participation in global value chains – in terms of greater exports of
intermediate goods.
Better theoretical basis needed to calculate VA trade costs
VA trade costs may be best interpreted as trade connectivity indicators
38
Trade Facilitation Indicators: the potential impact of trade
facilitation on developing countries' trade
OECD (2013)
A
Trade facilitation indicators
B
Data and methodology
C
Results
D
Conclusion
.E
http://www.oecd-ilibrary.org/trade/trade-facilitationF
indicators_5k4bw6kg6ws2-en
39
Trade facilitation indicators: Introduction
- The paper assesses the impact of several trade
facilitation indicators on developing countries’ trade as
well as the impact of such indicators on trade costs
reduction.
- Relevant trade facilitation indicators are analyzed to
suggest the prioritization of trade facilitation measures
for governments and to provide the technical assistance
to developing countries in a more systematic way
- 16 trade facilitation indicators are constructed,
corresponding to the main provisions of the WTO Trade
Facilitation Agreement
40
Trade facilitation indicators: Introduction
Trade Facilitation Indicators are categorized as follows:
a) Information availability
b) Involvement of the trade community
c) Advanced rulings
d) Appeal procedures
e) Fees and charges
f) Formalities – documents
Trade costs analysis are
g) Formalities – automation
focused on item (a) to (l)
h) Formalities – procedures
i) Cooperation – internal
j) Cooperation – external
k) Consularization
l) Governance and impartiality
m) Transit fees and charges
n) Transit formalities
o) Transit guarantees
p) Transit agreements and cooperation
41
Trade facilitation indicators: Data
-
Data sources for the analysis of the TFIs impact on trade costs:
-
Trade costs from ESCAP trade costs database
-
Trade facilitation indicators: Calculated by OECD based on:
- Their own survey data collection, supplemented by
- Global Express Association questionnaires covering
transparency, customs efficiency and post-release process
- Doing business indicators from World Bank
- Logistics Performance Index from World Bank
- World Economic Forum – Global Competitiveness Report
- Institutional Profile Database from CEPII
- APEC Sub-committee on Customs Procedures – 2010
Evaluation Report on Customs Activities in APEC
- Southern Africa Trade Hub Report
42
Trade facilitation indicators: Methodology
- The study runs cross sectional model of trade costs
(average of 2002-2005) on several indicators as follows
where
43
Trade facilitation indicators: Results
44
TFIs contributing most to reduction of
trade costs




Sub-Saharan Africa: (g) Formalities – automation, (f) Formalities documents and (b) Involvement of the trade community (estimated
potential reductions of 2.3%, 1.7% and 1.2% respectively);
Middle East and North Africa: (g) Formalities – automation
((1.6%), (b) Involvement of the trade community (1.3%) and (h)
Formalities – procedures (0.9%).
Asia: (g) Formalities – automation (2.1%), (f) Formalities –
procedures (1.5%) and (d) Appeal procedures (0.9%).
For Latin America: (h) Formalities – procedures (2.0%), (f)
Formalities – documents (1.5%) and (l) Governance and
impartiality (1.0%).
45
http://www.oecd-ilibrary.org/trade/trade-facilitation-indicators_5k4bw6kg6ws2-en
Other Data Sources of Trade
Facilitation / Trade Cost indicators
• Other possible databases for trade facilitation
– Doing Business Database [http://www.doingbusiness.org/]
– Logistics Performance Index Database [http://lpi.worldbank.org/]
– Liner Shipping Connectivity Index Database
[http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx?sRF_A
ctivePath=p,11&sRF_Expanded=,p,11]
– Global Competitiveness Index Database
[http://reports.weforum.org/global-competitiveness-report-20142015/]
– ESCAP International Supply Chain Connectivity (ISCC) Index
[http://artnet.unescap.org/databases.html#fourth]
– UPCOMING: UNRCs Global Trade Facilitation and Paperless Trade
Implementation Survey 2015
Concluding remarks


A lot of potential for relevant and better analysis of trade
costs and trade facilitation remains
Macro-level analysis should be continued, but important
to collect better data on trade costs…
47
Trade Transactions:
Buy-Ship-Pay Model
48
Trade costs:
http://artnet.unescap.org
49
For more
information on
what we do on
trade and
investment at
ESCAP,
artnet.unescap.org
Visit our website at:
 www.unescap.org/tid
 http://www.unescap.org/ourwork/trade-investment/tradefacilitation
unnext.unescap.org
THANK YOU
50
ANNEX




Derivation of trade costs equation
Data and Sources
Trade cost composition (AvW, 2004)
Comparison with other measures
51
Appendix – Derivation of Trade Cost Equation
1
YiYi  tii 


X ii 
Yw   i Pi 
1
Y jY j  t jj

X jj 
Yw   j Pj




YiY j  tij

X ij 
Yw   i Pj




1
1
Y jYi  t ji 


X ji 
Yw   j Pi 
52
2/6/2013
Appendix – Derivation of Trade Cost Equation

Multiply the equations for internal trade and the
equations for international trade to give two new
equations:
YY
X ii X jj  i i
Yw
1
 tii 


  i Pi 
YiY j  tij

X ij X ji 
Yw   i Pj

1




1
Y jY j  t jj 


Yw   j Pj 
1
Y jYi  t ji 


Yw   j Pi 
Divide those two equations and GDP and multilateral
resistance cancel out:
1
X ij X ji  tij t ji 


X ii X jj  tii t jj 
53
2/6/2013
Appendix – Methodology: Inverse Gravity

Points to note about our approach:

This is not an econometric estimation, so issues such as endogeneity
and omitted variables bias do not arise

Inverse gravity relies heavily on theory, but the formula for τ takes
basically the same form for any of the theories that are currently
standard in the literature

All that is required to implement inverse gravity is data on inter- and
intra-national trade, along with a parameter assumption as to sigma

Ad valorem equivalents are highly sensitive to the choice of sigma,
but index numbers are not
54
Appendix – Data and Sources

To calculate trade costs between countries i and j, we need data on:





Getting the international trade data is straightforward:




Exports from i to j
Exports from j to i
Production in country i that is also consumed there, in gross shipments
terms (not value added)
Production in country j that is also consumed there, in gross shipments
terms (not value added)
WITS-UN Comtrade
Aggregate into two macro-sectors, manufacturing (ISIC D) and
agriculture (ISIC A and B) using a WITS concordance
Adjustment for re-exports using other sources for a small number of
countries
Getting the intra-national trade data is less straightforward
55
Appendix – Data and Sources

For some countries, data on domestic production in gross
shipments terms are available through the UN national
accounts system




Coverage is up to 124 countries
Conversion from Local Currency Units to USD using the WDI
GDP exchange rate
Calculation of intra-national trade as domestic production
less total exports to the rest of the world
For countries for which gross domestic production is not
available, we infer it from GDP
56
Appendix – Data and Sources

For those countries that lack domestic production in
gross shipments terms:





57
We take GDP data by ISIC aggregate from the WDIs,
supplemented by the UN national accounts system
GDP data cannot be used directly because they are in value
added not gross shipments terms (i.e., they net out
intermediate input use)
We therefore calculate average gross shipments to value added
ratios for the two ISIC aggregates for those countries where
we have both sets of data
We use those ratios to ―gross up‖ the value added data to
their estimated gross shipments equivalents
We then calculate intra-national trade as domestic production
less total exports to the rest of the world
Appendix – Trade costs composition
Direct evidence on border costs shows that tariff barriers are now low in most countries, on
average less than 5% for rich countries, on average between 10-20 % for developing
countries.
Estimated Trade Costs in Industrialized Countries
Trade Costs
(170%)
Border
related trade
barriers**
(44%)
Transport
Costs
(21%)
Freight
costs
Transit
costs*
(9%)
Policy
barriers
(Tariff and
NTBs)
(8%)
Language
barrier
(7%)
Currency
barrier
(14%)
Retail and
wholesale
distribution
costs
(55%)
Information
costs barrier
(6%)
Security
barrier
(3%)
*Tax equivalent of the time value of goods in transit.
** The combination of direct observation and inferred costs, which, according to author, is an extremely rough breakdown
58
Source: Anderson and van Wincoop (2004)
Appendix – Comparison with other
measures

How does our methodology compare with other measures
that capture concepts similar to trade costs?




59
OTRI: Captures tariffs and NTMs for which data are available only;
does not include other policy factors (trade facilitation, connectivity,
logistics) or non-policy factors (geography, history, institutions)
Doing Business: Captures costs between the seller’s factory and the
port only; excludes international transport costs, trade barriers in
the importing country, and other factors that drive a wedge between
prices
Logistics Performance Index: Also only captures costs between the
seller’s factory and the port; excludes ―between the border‖ factors,
as well as geography, history, etc.
CIF/FOB ratios: Captures international transport costs only, not
other factors that make it more costly to trade internationally rather
than domestically
2. Methodology: Inverse gravity


Applied international trade typically uses the gravity
model to analyze the impact of a particular trade cost
factor on bilateral trade flows
Anderson and Van Wincoop (2003, 2004) provide the
canonical model:
YiY j  tij

X ij 
Yw   i Pj





1




X is exports from i to j
Y is GDP
t is iceberg trade costs
Sigma is the intra-sectoral elasticity of substitution
Pi and P are the multilateral resistance terms
2. Methodology: Inverse gravity

A typical gravity paper controls for a range of factors
(geography and history) and then adds another trade cost
source to see whether it has a significant impact on bilateral
trade







NTMs and product standards
RTA membership
Trade facilitation
Logistics performance
Air or maritime connectivity
Entry barriers
In principle, the estimates from different gravity papers can be
combined to give an overall picture of the level of trade costs,
but only Anderson and Van Wincoop (2004) have done so:
hence their 170% ―headline‖ number
61
2. Methodology: Inverse gravity

There are two inter-related problems with the standard
approach:

The focus is on one source of trade costs at a time, rather
than on a comprehensive measure of total trade costs



There is always the possibility of omitted variable bias

62
No understanding of the ―big picture‖ as regard to overall trade cost
Some policy forums, such as the Asia-Pacific Economic Cooperation,
have focused their trade facilitation efforts on the reduction of ―trade
transaction costs‖; but measurement and assessment of performance
has proved difficult using standard techniques
to the extent that an omitted source of trade costs is correlated with
an included one (which is highly likely)
2. Methodology: Inverse gravity

The methodology is very simple, and is based on some basic algebra
done with the standard gravity model

Take two countries i and j

That gives four gravity models for each direction of international
trade, and two types of internal (intra-national) trade

The four equations allow us to eliminate the two unobservable
multilateral resistance terms as well as GDP, leaving just intranational and inter-national trade and intra- and inter-national trade
costs

Note that there is no assumption that trade is balanced or that
trade costs are identical in both directions
63
2. Methodology: Inverse gravity

Summarizing the algebra, our measure of ad valorem trade costs:
1
2
 tij t ji 
 X ii X jj 



 ij   ji  
1  

X X 
 tii t jj 
 ij ji 
1
2  1
1

For the purposes of our work, τ (“trade costs”) is the geometric
average of trade costs from i to j and from j to i relative to intranational trade costs in each country

The intuition is that keeping all else constant, a rise in the ratio of
international trade relative to domestic trade must be associated with a fall
in international trade costs relative to domestic trade costs

Data on international trade (Xij, Xji) are relatively easy to come by, but data
on intra-national trade (Xii, Xjj) are more complicated…
64
4. Explaining trade costs (semi-partial R2*)
Covariance
Cost of Starting a Business
Logistics Performance Index
Air Connectivity
Liner Shipping Connectivity
Exchange Rate
RTA
Tariffs
Same Country
Common Colonizer
Colony
Common Language (Official)
Common Language (Ethno.)
Common Border
Distance
0
65
5
10
15
20
25
30
35
*the proportion of the observed variation in trade costs that is
accounted for by each independent variable, after controlling for the
influence of the other independent variables