Home Economics The Times Is Wrong About The Gravity Equation. Again

The Times Is Wrong About The Gravity Equation. Again

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We have before us, again, the example of Oliver Kamm. Who does so well here, almost manages to get it, then fails at the last fence.

Kamm is defending free trade and rightly so, For, as he says:

The theory points to certain conclusions that are amply confirmed in practice but aren’t obvious. First, the ability to specialise means that a country can benefit by importing goods even if it can produce them more efficiently than its trading partners. Second, the conventional wisdom that exports are a good thing and imports a cost has it the wrong way round. In fact, imports are a benefit. They expand consumer choice and pressure domestic producers to improve the range and quality of their output. Exports are the price we pay for these gains. Third, the gains from comparative advantage are so great that eliminating barriers to imports unilaterally makes sense.

That is all correct even if we should not be talking about a “country” as the unit for countries don’t trade with countries. We can just about say economies do but it’s companies and individuals in reality. The distinction matters even if not particularly at this point.

It’s here that the wobble appears:

Second, in trade economics there is a very robust finding known as the gravity equation. It predicts that bilateral trade between two parties depends largely on the size of these respective economies and the distance between them. The evidence is that large and close economies trade more than small and distant ones. Britain’s trading interests, even outside the EU, will be served more by a deep relationship with the huge single market on its doorstep than by an agreement with smaller economies, such as Australia and New Zealand. Our negotiators would do well to understand that.

No, that’s not what the gravity equation does say and the mistake is indeed important in this instance.

For it does not talk of geographic distance, even if it is often observed to match the predictions of the equation. It talks of economic distance. Vienna and Bratislava are not that far apart. Indeed one stylised and even possibly true facts bandied about is that the tram lines of the one reach the other. Yet from 1950 to 1989 Vienna traded more with Munich than it did with its near neighbour – that border and all that barbed wire getting in the way.

For centuries Newcastle traded more with London than it did with Carlisle. The absence of a railway – or even a decent road – across the moors meaning the economic distance was much greater than the coal ships’ scuttle down the coast.

Economic distance is, at least in part, determined by the rules that we put in place over what trade can be between locations. It also incorporates such things as differing languages, habits, expectations and yes, clearly, transport links.

The importance here being, of course, that what rules govern trade between the newly liberated UK and the remnant EU will be the determinants of that distance which rules the gravity equation of trade.

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2 COMMENTS

  1. I think Kamm has also omitted mention of our single biggest trade partner, which is ourselves. Ah-ha, he will say but the UK already has free trade with itself so there’s no agreement to negotiate or improve.
    Well not really, you can’t freely exchange your labour for money at a price between 1p and £8.59 an hour, or sell a body part, share premises to sell sexy services, or exchange recreational drugs. So we do have a trade agreement with ourselves, we just call them laws saying what you can’t do, and UK’s trade with itself is around 6 times what it is with the EU.

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