Today’s basic trade thread: gravity. Gravity in trade means that distance matters in trade. (Thread)
Here’s an excerpt from one of the leading international economics textbooks (Krugman/Obstfeld/Melitz): “All estimated gravity models show a strong negative effect of distance on international trade; ...
... typical estimates say that a 1 percent increase in the distance between two countries is associated with a fall of 0.7 to 1 percent in the trade between those countries.”
What explains this effect? Krugman goes on to explain this with transport cost, but also less tangible factors: contacts, for example. Borders, by the way, aggravate the situation: Krugman states the Canad—US border deters trade like a distance of 1500-2500 miles.
It is certainly true that modern technology (superstar in this regard: the container - there’s even a book on that) has reduced the cost of distance and its significance. But there are limits to that.
Many services currently cannot be delivered over distances or only at a disadvantage and cost, namely those requiring physical objects: think haircuts. But think also car repair services. Or servicing needs of goods in general.
Finally some services that CAN be delivered via distances nevertheless become less attractive if that is done. Think of architects: They can make plans and e-mail them. And that is done quite a bit, I guess.
But architects can also help with organising work, they have contacts, they know who does what (and does it well) and get them more quickly than individuals do. So for huge projects - that’s less of a consideration. But for small projects that counts.
Technology will certainly lead to a further drop in the relevance of gravity, but as long as we have bodies and use objects and rely on the physical world, it is unlikely to become irrelevant.
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