Import Price - Elasticities : Reconsidering the Evidence

Recent economic geography and trade empirical studies based on monopolistic competition [Hanson, 1998; Head and Ries, 1999; Hummels, 1999], suggest high levels of trade price elasticities (between 3 and 11). However, direct estimations of price-elasticities in trade equations, using price indexes at aggregate or industry levels, usually lead to much lower values (around unity). In this paper, we show that those inconclusive results may be due to an econometric misspecification of these equations, as well as measurement errors in import price indexes. We re-estimate import price-elasticities from gravity-like equations using methods of transformed least squares and instrumental variables. Our study is based on compatible bilateral trade and activity data from the OECD and INSEE for 14 importing countries, 16 trading partners, 27 industries and 23 years. When suitable instrumental variables are used, we find relatively high price-elasticities, in majority ranging from 1 to 13, the highest estimates corresponding to industries producing homogeneous goods. These results support recent studies on substitution elasticity estimates using monopolistic competition. They are also consistent with finite markup evaluations in the literature as well as reasonable estimates of the elasticity of trade costs with respect to distance.