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The Trade Consequences of Pricey Oil

Abstract

This paper examines the trade and trade-induced welfare effects of oil prices. Using a gravity model of trade, the paper finds that the distance elasticity of trade significantly increases with the oil price. This suggests that high oil prices make trade less global, as they affect longer shipping routes more. The paper estimates that an increase in the oil price from $100 to $200 (in 2014 US$) would have similar trade effects as an import tariff around 17 percent for two countries 10,000 km away. This is akin to a 55 percent increase in shipping distance. This trade reduction would lower welfare by 0.03 percent in the average non-oil-exporting country.

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Notes

  1. Our gravity model also allows us to include country-pair fixed effects, leaving only the interaction of distance and oil prices as an explaining variable. This method is akin to Rajan and Zingales’ (1998) identification of the effect of financial development on growth via the interaction of sectoral finance-dependence with country-level financial-market developments.

  2. Assche, Gangnes, and Ma (2011) run a similar regression for China for the years 1988–2008 and find that high oil prices do affect the sensitivity of China’s export to distance.

  3. The expressions for the inward and outward multilateral resistance terms are P i = j (t ij j )εy j /y w 1/ε and Π j = i (t ij /P i )εy i /y w 1/ε.

  4. Both the two-way and three-way fixed effect models are estimated using the reghdfe Stata command. Only the results without county-pair fixed effects allow for estimates of the level of the distance elasticity, on top of its slope across oil prices. The −0.165 coefficient on the interaction yields distance elasticities between −1.1 and −1.6. The −0.106 coefficient is more precisely identified due to the inclusion of country-pair fixed effects and is closer to what was found for China’s exports by Assche, Gangnes, and Ma (2011) (−0.043).

  5. The Poisson pseudo-maximum-likelihood estimator was suggested by Silva and Tenreyro (2006) to include all zero trade flows and correct for heteroscedasticity problems.

  6. Note that the trade cost shock we take into account is the increase in distance elasticity, not the tariff equivalent, as the latter also involves tariff revenue that we would otherwise need to take into account.

  7. The model of Arkolakis, Costinot, and Rodriguez-Clare (2012) builds on Eaton and Kortum (2002) who first computed real wages as a function of import shares and the trade elasticity in order to quantify the gains from trade in a Ricardian model.

  8. The welfare effects we estimate are not the total welfare effects of higher oil prices but only those induced by higher trade costs and only for non-oil-exporting countries. We abstract from the losses due to higher energy costs not related to transport, such as heating costs in winter.

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Authors

Additional information

*David von Below works as an Economist at Copenhagen Economics, with a focus on energy, climate change and macroeconomics.Pierre-Louis Vézina is Lecturer in Economics at King’s College London.

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von Below, D., Vézina, PL. The Trade Consequences of Pricey Oil. IMF Econ Rev 64, 303–318 (2016). https://doi.org/10.1057/imfer.2016.3

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JEL Classifications

  • F14
  • Q43