Gravity estimations to correct the 'small shares stay small' bias in economic models

Sanjuán López, Ana Isabel; Resano Ezcaray, Helena

Gravity estimations to correct the 'small shares stay small' bias in economic models

Files

2015_183.pdf (1.22 MB)

Date

2015

Authors

Sanjuán López, Ana Isabel
Resano Ezcaray, Helena

Publisher

European Commission, Joint Research Centre

Typology

Research Report
Article

Abstract

The simulation of liberalization trade scenarios in economic models normally understate the export growth for countries with small initial trade shares but which nevertheless could be competitive under a new tariff regime. This downward bias is known as the ´small share stay small´ and it is inherent to the constant elasticity of substitution in the Armington demand specification. In this report, we show how the gravity equation can provide econometric estimates of the tariffs restrictiveness and trade shares after tariff liberalization and how these can be input into a General Equilibrium (CGE) model to remedy said bias. The fusion approach between gravity and CGE that we follow closely in this report was proposed by Kuiper and van Tongeren (2006) and further developed by Philippidis et al.(2014). As an empirical illustration, the method is applied to agro-food trade between EU and Mercosur where a pervasiveness of 'small-share' examples exists.