Trade costs : a natural experiment in South America

Abstract

This paper exploits a natural experiment in South America, the Pulp Mill Conflict, that introduced a time component to geographic distances to obtain accurate estimates of the elasticity of bilateral trade with respect to transport costs. Due to the construction of a pulp mill near a shared river, concerned Argentinian environmentalists blocked the main access to Uruguay as a (pacific) means of protest. As a result, the distances between Uruguay and several trading partners were temporarily extended. This distance shock presents a rare opportunity to include bilateral pair fixed effects in a gravity equation setting to account for all bilateral characteristics other than the time-varying distances. In addition, this paper exploits a unique database of both trade by land and actual land distances. The estimation results indeed show that the distance effect is much smaller (over 50% less) than the typical gravity model estimates, suggesting that the latter are overestimated and represent not just transport costs but also other country-pair characteristics.