Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 957: Heterogeneous Firms, Globalization and the Distance Puzzle

Mario Larch (), Pehr-Johan Norbäck (), Steffen Sirries () and Dieter Urban
Additional contact information
Mario Larch: University of Bayreuth
Pehr-Johan Norbäck: Research Institute of Industrial Economics (IFN), Postal: P.O. Box 55665, SE-102 15 Stockholm, Sweden
Steffen Sirries: University of Bayreuth
Dieter Urban: None

Abstract: Despite the strong pace of globalization, the distance effect on trade is persistent or even growing over time (Disdier and Head, 2008). To solve this distance puzzle, we use the recently developed gravity equation estimator from Helpman, Melitz and Rubinstein (2008), HMR henceforth. Using three different data sets, we find that the distance coefficient increases over time when OLS is used, while the non-linear estimation of HMR leads to a decline in the distance coefficient over time. The distance puzzle thus arises from a growing bias of OLS estimates. The latter is explained by globalization more significantly reducing the downward bias from omitting zero trade flows than it reduces the upward bias from omitting the number of heterogeneous exporting firms. Furthermore, we show that including zero-trade flows cannot solve the distance puzzle when using HMR. The HMR estimates are strongly correlated with the time pattern in freight costs reported by Hummels (2007).

Keywords: Distance puzzle; Gravity estimation; Zero trade flows; Firm heterogeneity

JEL-codes: F13; F14; F23

43 pages, March 5, 2013

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