Haskel and Wolf (1999)

119 tradeable goods by IKEA in 26 countries identical goods.

Modelled final price dependent on domestic competitors pricing strategy,
import price, local distributional costs
BUT differences in relative prices across countries for similar products
suggest that differences in local distribution costs do not explain price
divergence other strategic pricing factors like markup.
Engel and Rogers (1996)
Examined importance of distance between locations where goods are sold
and the presence of national borders separating locations in determining
LOOP failure.
9 Canadian cities and 14 US cities, 228 city pairs.
Distance and border are significant in explaining price dispersion.
Border 1780 miles, distance account for 20% of price dispersion,
border 32.4%
Nominal price stickiness (significant), integration of labour markets and
trade barriers.
Failure of LOOP. Geographical separation of markets make arbitrage more
difficult.
Final Price = Productivity + Elasticity of Demand + wage + intermediate

price
Time series on relative prices then cross-section of volatility measures.

Estimate volatility by using log price relative to price in other city =

distance + different country dummy + city dummy variables
Intuition:
Pricing to Market: Markups differs across locations and vary with
exchange rate changes, costs and wages, and productivity shocks.
Nontradable market more highly integrated on a national basis.
Direct costs of crossing border due to tariffs and trade restrictions.
Homogeneity in productivity shocks and labour market within same
country.
Control for Sticky price deflate by aggregate CPIs Sticky prices in
each country but exchange rate still changes exchange-regime nonneutrality less tempted for producers to change price in one location if
markets are separated

Evaluation & Robustness

Prices filtered for seasonal variation
Structural Break test at 1985 (large swings in USD), 1990 when NAFTA
came into effect
Deflate all variables by log of distance to reduce variance of error term
but no effect
Trade Barrier Costs does not explain price differences Informal barriers
like information costs?
Border Effect
Tinbergen (1962): Using Newtons gravity model to model bilateral trade

flows
Volume of trade = gravitational constant x masses / distance
Other control variables: Income per capita, adjacency, colonial links,
common language, EU dummy, same currency etc.
Adjacency: High trade flows between adjacent countries as they share
common border
Remoteness: trade also depends on distance from alternative trading
partners. Higher trade flows if the 2 countries located further away from
common market
McCallum (1995) US and Canada share border, free trade, similar
institutions and cultural traditions. Volatility of price differential measured
by standard deviation.
Border effect should be small!
Price = size + distance + border dummy + other control variables
Home dummy represents probability of domestic trade compared to
bilateral trade = 22 times.
Trade between region determined also by relative trade barriers with all
partners, weighting of remoteness variable to include border presence
Reasons
Border Effect Less than perfect market integration, imperfect
competition
Elasticity of substitution between domestic/foreign varieties due
to real price changes from exchange rate changes, income changes, High
degree of substitution can lead to high responsiveness of trade flows
even in modest trade barriers.
Evans (2000) home x product differentiation multiplicative variable
negative more differentiated and unique smaller elasticity of

substitution smaller border effect less domestic trade, more external

trade
Chen (2004) estimated border effect for EU countries. Choice of distance
measure
Technical Barriers to trade and product-specific information costs increase
border effects but non-tariff barriers not significant. Spatial clustering of
Firms accounted for elasticity of substitution in model. National trade
barriers like tariffs, exchange rate variability, transaction costs etc. not
significant in many papers. Technical barriers significant but not non-tariff
barriers. Support the role of informal barriers to trade.
Industry Level Trade
Chen(2004): industry matters eg. ready-mix concrete highest home
coefficient
added weight-to-value ratio of exports decreases border effect.
Different transport costs across industries. 6 times home bias. Technical
barriers significant but not non-tariff barriers, spatial clustering and
information costs significant.
Exchange Rate volatility
Wei (1996): Exchange rate volatility in international markets not
signficiant reason to explain home bias.
Head and Mayer (2000): Non tariff barriers in Europe not significant
Hillberry (1999): 7 types of trade barriers not significant between US and
Canada
Eg. tariffs, regulation, information costs, communication costs, public
procurement
Informal Barriers to trade: Rauch (1999)
In matching buyers and sellers, proximity and common language more
important for differentiated products. Higher search barriers to trade for
these products.
Heterogeniety in goods interfere with the ability to signal price and value,
this uninformativeness results in trade based on proximity and existing
ties (trading network instead of market)
3 categories: Organized exchanges, reference prices or neither
Common/organized exchange market helps also

Found that trade of differentiated products increases the most with

distance decrease, and increased ties, showing significant informal
barriers.

Economic Intuition: Differentiated products produced to suit domestic

demands (niche), incomplete information about foreign tastes less
foreign demand for differentiated goods. Common language/colonial ties
More similar tastes.
Spatial Agglomeration of Firms Wolf (1997) found that border effects
also apply for intranational trade and reasons can be learnt. These
include close states tend to have similar production patterns. Spatial
Agglomeration/clustering of production driven by comparative advantage.
Same constitution/institution homogeneity/ fixed exchange rate all
accounted for. Reasons is purely of a cost such as shipment, transaction
costs. Bilateral trade higher for states with similar production and trade
composition and structures. Important: not national trade barrier factor.
Industrial policies, large, self-sufficient states.
Correct measurement of distances?
Wei (1996): Measuring internal distances (how far countries are from
themselves) taking quarter of distance from economic centre of
nearest trading partner. Weird results as Frances internal distance 3
times smaller than Portugals while France is a bigger country. Realises
that halving distances halves effect and doubling distances doubles the
effect not robust. Depends too little on a countrys shape and internal
population distribution, and too much on the nearest neighbour.
Leamer 1997 assuming that countries are circular in shape, expected
distance beween selected points within circle is approximately the radius.
intra-distance = radius = square root of area/pi. Circularity hypothesis.
Supported by Nitsch.
Head and Mayer (2000) calculated both international and intra-national
distances by weighting the distances between reions by the economic
size of the regions. To account for varying economic activity over land
space, for eg. mountain regions do not have much economic activity and
commerce compared to urban areas which are busier.
Helliwell uses weighted average of intra- inter-city distances, rural-urban
distance, intra-urban distance.
Misspecification - Anderson and Van Wincoop(2003):

Bilateral trade increases as average barrier to trade with all other

partners increase Multilateral resistance pushes country to trade with
given bilateral partner

Argues that McCallum does not have multilateral resistance variables,

only have remoteness variable related to distance, does not account for
national border
Trade between two regions depend on relative trade barriers bilateral
trade barriers between them relative to average trade barriers faced
with all partners
Large country: multilateral trade resistance not so much affected by
increase in trade barriers as they do not apply within country
Less regions for small country to divert exports to relative within
country trade increases more
Multilateral resistance for small country increases more relative trade
resistance rises less bilateral trade drop less trade within country
increases.
Distance and border presence accounted for in the variable.
CES utility function, micro individual utility maximization problem, general
equilibrium model
Omitting relative prices leads to over-estimation of border effect
controlled using fixed effects
Size of country matters smaller country higher border effect as drop in
international trade can lead to much larger increase in domestic trade
Includes multilateral trade resistance variables
Criticisms
Chen lack of info on domestic shipment distances, measures of internal
distances.