Bonus vetus OLS: A simple method for approximating international trade-cost effects using the gravity equation

Using a Taylor-series expansion, we solve for a simple reduced-form gravity equation revealing a transparent theoretical relationship among bilateral trade flows, incomes, and trade costs, based upon the model in Anderson and van Wincoop [Anderson, James E., and van Wincoop, Eric. "Gravity with Gravitas: A Solution to the Border Puzzle." American Economic Review 93, no. 1 (March 2003): 170-192.]. Monte Carlo results support that virtually identical coefficient estimates are obtained easily by estimating the reduced-form gravity equation including theoretically-motivated exogenous multilateral resistance terms. We show our methodology generalizes to many settings and delineate the economic conditions under which our approach works well for computing comparative statics and under which it does not. (c) 2008 Elsevier B.V. All rights reserved.