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A Solution to the Missing Globalization Puzzle by Non-CES Preferences

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  • Hakan Yilmazkuday

    (Department of Economics, Florida International University)

Abstract

One channel of welfare-improving globalization is through the increasing integration of trade. Although this is attributed to decreasing effects of distance across countries, the workhorse models of gravity fail to capture it, the so-called the missing globalization or the distance puzzle. This paper shows that this puzzle may be due to the restricting assumption of constant elasticity of substitution (CES) preferences working behind the gravity models. We test the validity of this assumption for different trade intervals and show that it is violated due to the distance elasticity of trade decreasing with the amount of trade. Accordingly, we consider a type of non-CES utility function, namely constant absolute risk version (CARA), and analytically show that the negative relation between trade and distance elasticity of trade is captured by CARA preferences. We estimate the gravity equation implied by CARA preferences, empirically confirm the endogenous relation between trade and distance elasticity of trade, and show that the distance puzzle is solved under CARA preferences. According to the data set used, CARA preferences are also econometrically selected over CES preferences based on their goodness of fit.

Suggested Citation

  • Hakan Yilmazkuday, 2016. "A Solution to the Missing Globalization Puzzle by Non-CES Preferences," Working Papers 1608, Florida International University, Department of Economics.
    • Handle: RePEc:fiu:wpaper:1608
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    Cited by:

    1. Yulin Hou & Yun Wang & Hakan Yilmazkuday, 2023. "Gravity channels in trade," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 32(1), pages 37-65, January.
    2. Zhao, Xin & Calvin, Katherine & Wise, Marshall & Iyer, Gokul, 2021. "The role of global agricultural market integration in multiregional economic modeling: using hindcast experiments to validate an Armington model," Conference papers 333309, Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project.
    3. Xin Fan & Shan Jin & Zeyu Chen, 2023. "Who Benefits from Domestic Market Integration?," Journal of Happiness Studies, Springer, vol. 24(6), pages 2083-2109, August.
    4. Bělín, Matěj, 2020. "Time-invariant regressors under fixed effects: Simple identification via a proxy variable," Economics Letters, Elsevier, vol. 186(C).
    5. Yilmazkuday, Hakan, 2016. "Constant versus variable markups: Implications for the law of one price," International Review of Economics & Finance, Elsevier, vol. 44(C), pages 154-168.
    6. Samuel Standaert & Stijn Ronsse & Benjamin Vandermarliere, 2014. "Historical trade integration: Globalization and the distance puzzle in the long 20th century," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 14/897, Ghent University, Faculty of Economics and Business Administration.
    7. Xu, Tao, 2019. "Economic freedom and bilateral direct investment," Economic Modelling, Elsevier, vol. 78(C), pages 172-179.
    8. Zhao, Xin & Calvin, Katherine V. & Wise, Marshall A. & Iyer, Gokul, 2021. "The role of global agricultural market integration in multiregional economic modeling: Using hindcast experiments to validate an Armington model," Economic Analysis and Policy, Elsevier, vol. 72(C), pages 1-17.

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    More about this item

    Keywords

    Distance Puzzle; Non-CES Preferences; CARA Preferences;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade

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