The Short-Run Effects of Product Differentiation on Trade

Abstract

Gravity models of trade have long found that estimates of trade determinants differ across both time and products. In this paper, we demonstrate that there is a systematic relationship between these two influences. Past research has found that trade factors such as distance, common language, and preferential trade agreements matter more for differentiated products than homogeneous products. We find, however, that these differences are only a short-run phenomenon. As goods trade for longer periods of time, differentiated and homogeneous goods exhibit increasingly similar trade patterns. We propose a search model of trade that explains this behavior and find strong empirical support using gravity models that account for product type and trade duration. Additionally, we identify several other relationships between trade determinants and time. Determinants that affect recurrent trade costs, such as distance and preferential treatment, become more important over time. Determinants that impact fixed costs, such as language and colonial ties, become less important. These findings indicate that accurate modeling of trade through time and across different products ought to consider the systematic relationships across both dimensions.

Keywords: trade, differentiation, duration, gravity, search

JEL Classification: F10, F14, D83