From Case Study Counting to Measuring 1
4 m easuring trade COsts
4.2 Direct measurement of trade cost components .1 First stage: Building trade cost proxies
The first step in the ‘bottom-up’ approach to the estimation of trade costs consists in getting a handle on their direct measurement through a limited set of components, as outlined in Figure 2.3:
• A vector zij of geographic and historic attributes of country pair (i, j) as they typically appear in a gravity equation: distance, common language, common colony, etc.
23 An extreme case of this syndrome is Sao Tomé & Principe, which until recently had not managed to light its single runway, forcing airlines to re-route flights when they were late. To this day, the runway is in such bad shape that airplane tires have to be changed every four landings, and most of the airlines serving the country are blacklisted by the EU for safety lapses; all this in a country for which tourism could be a primary growth driver. Borchert et al. (2012) find that high transport costs for landlocked countries are largely due to their respective transport policies.
• A vector τij of trade policy factors affecting bilateral flows, including applied tariffs (τij) and non-tariff barriers (nij).
• A pair of vectors bi, bj subsuming relevant attributes of each country in the pair, including landlockedness, infrastructure quality, the investment climate, and AFT flows.
The trade cost function tij aggregates these four broad components to give:
tij = ϕ(zij, τij, bi, bj) (4)
How about measurement? Typically, gravity variables in zij are widely available (e.g. from the CEPII website). As for shipping costs, there are several possible routes. One is to use distance as a proxy; the other consists of following the pioneering work of Limão and Venables (2000) and use direct quotes from an international shipping line (more on this below). Both approaches suffer from the same drawback: as we have seen, the elasticity of freight costs to distance has evolved with the rise of air freight, although at present there is no database on bilateral air freight costs (and nonlinearities in airline pricing policies may make such a database impossible to assemble in a reliable way). Alternatively, some researchers have used CIF/FOB ratios, but those have proved fatally unreliable as measures of trade costs.24
Tariffs are easily (although incompletely) available from the Trade Analysis and Information System (TRAINS). Non-tariff measures are available from 65 countries in a currently expanding database collected under UNCTAD’s coordination.
As for trade-relevant country characteristics (bi and bj), there has been much progress over the last decade, as the World Bank and other institutions have compiled data on trade facilitation, the investment climate, customs delays, clearance costs and administrative procedures. These have been compiled and elaborated into several composite indices such as the Logistics Performance Index (LPI) database, Doing Business (DB) Surveys, and World Bank Enterprise Surveys. Typically, gravity-based estimates either use the raw data from those surveys (Chen et al., 2006; Portugal-Perez and Wilson, 2008) or rankings/indices (Hoekman and Nicita, 2008). Information on non-tariff measures, available on TRAINS, has been used as dummy variables (Chen et al., 2006; Helbe et al., 2007) or after estimating AVEs (Hoekman and Nicita, 2008; Portugal-Perez and Wilson, 2008). Several studies apply principal component analysis (PCA) or factor analysis (FA) on different indicators to generate composite indices (see, for example, Helbe et al. (2009) for their transparency index, and Wilson et al.
(2003), Balchin and Edwards (2008) or Francois and Machin (2013) for their
24 Measurement error and holes in the data are rife; moreover, under/overinvoicing is not independent from the level of governance in the trading countries (Limão and Venables, 2000; Hummels and Lugovskyy, 2006).
infrastructure and institution index). Finally, some studies have relied on their own survey of freight forwarders or experts (Djankov et al., 2010; Duval, 2006).25
Notwithstanding statistical issues – such as large changes in a country’s ranking that turn out to be statistically insignificant, as is sometimes the case with the LPI and Worldwide Governance Indicators (WGI), for example – the basic drawback of indices and rankings is that they are composite with arbitrary weights and ad hoc aggregators, making it difficult to relate changes in their scores to changes in measurable and policy-relevant underlying components.
4.2.2 Second stage: From costs to trade.
With trade cost estimates in hand, the second stage relates trade flows to trade costs (only in a few studies discussed in Section 6 are trade costs related to AFT flows, as suggested above). This is typically done, again, using the gravity model. Assuming a log-linear functional form for tij and, as is often the case in actual estimation, a single component in bi (bj),
ln tij = ln[zija1 + τija2 + a3bibj]; (5) Log-linearising (1), substituting (5), and estimating on a cross-section of countries gives an estimation equation of the form:26
ln xij = c + δi + δj + β1zij + β2τij + β3(bi ×bj) + ln uij (6) where
c = − logYW
δi = logYi − log∏i + bi (7)
δj= logYj − logPj + bj.
In (6), all country-specific variables are subsumed in country fixed effects δi
and δj, precluding the estimation of the direct effect of bi and bj – an unfortunate drawback of the gravity equation, although typically variables like customs costs/delays or DB scores are entered in interaction form, as in (6), transforming them into a bilateral variable. Identification is improved when (6) is estimated on a panel of countries, but as Baldwin and Taglioni (2006) argued, estimation should then involve country-time effects which would similarly absorb
time-25 Djankov et al. (2010) collected their data on time to transport from a survey administered to 345 freight forwarders in 126 countries for 2005. The data give the time it takes for a 20ft standard container carrying three categories of standard goods (textiles and apparel, coffee, tea and spices) to carry out four stages of exporting procedures (pre-shipment activities, inland carriage, port handling, customs and technical control). Their estimates used several approaches to deal with the endogeneity of trade costs to the volume of trade. Regrettably, the limited number of freight forwards in each country is unlikely to be representative of trade costs (see Volpe and Graziano, 2012).
26 This way of writing the equation is somewhat misleading as it ignores zero flows. Santos Silva and Tenreyro (2006) have shown that the Poisson or negative binomial estimators (and their zero-inflated variants) are the most appropriate to handle both zero flows and heteroskedastic errors.
variant country characteristics. In addition, dyad fixed effects δij would absorb all time-invariant country-pair characteristics. Finally, many of the trade cost proxies as well as NTM dummies are available for one year only.27
What about AFT in all this? AFT enters (4) via two channels: (i) by reducing trade barriers and improving indicators of soft infrastructure (tariffs, NTM measures, harmonised standards) through technical assistance activities; and (ii) by improving the quality of hard infrastructure. Unfortunately, only the latter channel can be credibly measured, hence ‘the fear [by the development community] that requiring that every initiative be justified in this way [basing policies on hard evidence] will bias decisions on what is measurable and easy to evaluate’ (OECD, 2011, p. 33).