Projects per year
Abstract
In their highly influential paper, “Does Trade Cause Growth?,” Frankel and Romer estimate a trade equation to predict bilateral trade shares, which are in turn aggregated to construct an instrument for trade openness in income regressions. The Frankel-Romer approach has gained widespread popularity as a method to generate instruments for trade and many other outcome variables from estimated bilateral relationships. In this paper, we show analytically and empirically that the Frankel–Romer instrument gives inconsistent estimates for the effect of trade on income when fitted values for zero and missing bilateral shares are omitted from the instrument. This leads to a violation of the exclusion restriction because the instrument captures the endogenous variation in the observed probability that countries engage in bilateral trade, as reflected in the number of observed trading partners. This violation disappears when predicted bilateral shares for all observed and unobserved bilateral trade relationships are included in the instrument for trade openness.
Original language | English |
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Number of pages | 16 |
Journal | Journal of Applied Econometrics |
Volume | 36 |
Issue number | 4 |
DOIs | |
Publication status | Published - Jun 2021 |
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Government, Institutions and Economic Activity: A Long Term Analysis
Madsen, J. (Primary Chief Investigator (PCI)), Raschky, P. (Chief Investigator (CI)) & Hodler, R. (Partner Investigator (PI))
Australian Research Council (ARC), Monash University, Universität St. Gallen (University of St Gallen)
1/01/15 → 31/12/20
Project: Research
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Inequality and Economic Growth: Implications for Australia and the OECD
Madsen, J. (Primary Chief Investigator (PCI))
Australian Research Council (ARC), Monash University
1/01/17 → 18/01/19
Project: Research