Gravity and Information:Heterogeneous Firms, Exporter Networks and the ‘Distance Puzzle’

Abstract

Distance effects in empirical gravity equations appear to be too high to be explained by transport costs alone. Moreover, despite the strong and ongoing reduction of transport costs, the estimated coefficients are rather increasing than decreasing over the last six decades. To address the two dimensions of this 'distance puzzle', this paper proposes a model of international trade in which heterogeneous firms create informational networks to reduce their fixed costs of exporting. Since the variable trade cost (distance) affects the number of exporters, which in turn affects the available information, the fixed cost of exporting is endogenously increasing in distance. The model thus delivers higher predictions for the level of distance effects and, in addition, a quality improvement of the networks over time implies increasing distance elasticities. Major implications of the model regarding the effects of firm heterogeneity and market structure on distance effects are supported by existing empirical evidence. An empirical gravity equation is used to estimate the effect of exporter networks on distance coefficients. In the light of the results the empirical findings on the role of distance on international trade appear considerably less puzzling.