Francesco Marchionne

A Commentary on the Gravity Equation in International Business Research

Purpose – This commentary aims to discuss methodological issues and practical concerns of international business scholars who apply the gravity equation in their research.Design/methodology/approach – The paper summarizes and compares theories and several advanced empirical specifications in the gravity equation.Findings – The paper proposes a relatively low‐cost specification and estimation to implement such correction, which is robust in the presence of various endogeneity effects and non‐stationary variables. In the presence of zero‐values in the dataset, however, the multilateral specification is best estimated with a Poisson maximum likelihood.Originality/value – The most important message of the commentary is that this equation should correct for multilateral resistance factors.

Trade Costs and Economic Development

We test the hypothesis of the circular causality between trade costs and degree of economic development using data on Italian provinces. Using different methods to control for multilateral resistance, we apply a gravity equation to estimate sectoral exports to 188 countries over the period 1995-2004. Provincial trade costs are constructed as the sum of five province-specific elasticities, including distance, adjacency, and common money. We find that Italian provinces are heterogeneous with respect to trade costs. These costs are influenced by lagged provincial per capita income and industrial structure. In turn, trade costs influence future provincial per capita income. This two-way relationship between trade costs and income is broadly consistent with the cumulative causation process emphasized by the New Economic Geography.

Trade Costs and Economic Development: ECONOMIC GEOGRAPHY

Abstract In our study, we tested the hypothesis of the bidirectional causality between trade costs and economic development using data on Italian provinces. Using different methods to control for multilateral resistance, we applied a gravity equation to estimate sectoral exports to 188 countries over the period 1995–2004. Provincial trade costs were constructed as the sum of five province-specific elasticities, including distance, adjacency, and common money. We found that Italian provinces are heterogeneous with respect to trade costs. These costs are influenced by lagged provincial per capita income and industrial structure. In turn, trade costs influence future provincial per capita income. This bidirectional relationship between trade costs and income is broadly consistent with the two-way causation process emphasized by the New Geographical Economics.

Banking Regulation, Institutional Quality, and Financial Crises

This paper examines how financial regulation and institutional quality affect the probability of a banking crisis using a panel of 132 countries over the period 1999-2011. We find that the probability of a financial crisis increases moving from low to medium levels of regulation and decreases from medium to high levels of regulation. This relationship is sensitive to the institutional quality and creates a liberalization trap for “happy mediums”: only countries endowed with good institutions can undertake a liberalization process. This effect is larger for European Union (and Eurozone) members than other countries. As heterogeneity in institutional quality generates also different preferences, international agreements on banking regulation are hard to achieve, especially in Europe. Our results are consistent with several robustness econometric exercises.

Do Rating Agencies Confirm or Surprise the Market? Market Efficiency Hypothesis vs Conspiracy Theory.

This paper examines the impact of credit ratings for sovereign bonds on bond price. We test whether credit rating agencies’ announcements surprise the market as predicted by the conspiracy theory or confirm what the market has priced already as postulated by the market efficiency hypothesis. We apply an event-parameter study to a CAPM-like model using a sample of 43 bond indexes over the period 1962-2013. The post-announcement reaction is three times larger than the pre-announcement adjustment, in particular for negative assessments. The relationship is stronger in Eurozone and intensifies since 2000. Our results are robust to different estimators, specifications, and variables definitions and weaken gradually with the increase in the event window size. This empirical evidence supports the conspiracy theory and is in line with the increasing power of credit rating agencies.

GROWTH, DEBT, AND INEQUALITY

After the 2009 global recession, many papers identified a non-linear inverted Ushaped relationship between economic growth and sovereign debt. However, their results are mixed regarding the exact turning point. According to the traditional view, we assume debt-to-growth causality and show that the mixed results depend on the heterogeneity of the non-linear debt-growth relationship. In our sample of 27 countries over the period 1994-2010, countries with a higher Gini index, our measure of income inequality, show lower threshold points upon which further increases in debt reduce growth, but a higher sensitivity of growth to debt changes. Hence, the more even the income distribution, the more a country should be fiscally virtuous to avoid affecting growth. The implication is that policies promoting a more equal income distribution reduce (increase) economic growth in (not) highly indebted countries.

Eurobond: 'Yes, We Can!' (Eurobond: 'Si può fare')

This paper explores a potential new exit strategy from the sovereign debt crisis affecting European countries since 2010. The proposal is based on the securitization of sovereign debt and the transfer of its surer tranche to a bond at the European level with jointly responsibility between country members, the Eurobond. Mixing economic concepts differently from other similar proposals, this (perfectible) exit strategy is convenient, feasible and worthy to be realized. From a financial viewpoint, it would be the greater innovation from the introduction of Euro. From a fiscal viewpoint, it could lead gradually to the political union of Eurozona avoiding the scepticism of more virtuous countries. The idea can be applied also at the national level to debts of local administrations: the mutual monitoring between partners and the threat of exclusion to future issues could inventive virtuous behaviors reducing sovereign debt endogenously.

The (In)Effectiveness of Announcements of Banking Bailouts

We analyze the effectiveness of government policies aimed at shoring up banks’ financial conditions during the 2008-2009 financial crisis. Governments injected into troubled institutions massive amounts of fresh capital and/or guaranteed bank assets and liabilities. We employ event study methodology to estimate the impact of government-intervention announcements on bank valuation. Using traditional approaches, announcements directed at the banking system as a whole were associated with positive cumulative abnormal returns whereas announcements directed at specific banks with negative ones. Findings are consistent with the hypothesis that individual institutions were reluctant to seek public assistance. However, when we correct standard errors for bank-and-time effects, virtually all announcement impacts vanish. The policy implication is that the large public commitments were either not credible or deemed inadequate relative to the underlying financial difficulties of banks.

The Banking Bailout of the Subprime Crisis: Big Commitments and Small Effects?

This paper examines government policies aimed at rescuing banks from the effects of the financial crisis of 2008-2009. Governments responded to the crisis by guaranteeing bank assets and liabilities and by injecting fresh capital into troubled institutions. We employ event study methodology to estimate the benefits of government interventions on banks. Announcements directed at the banking system as a whole were associated with positive cumulative abnormal returns whereas announcements directed at specific banks with negative ones. The effects of foreign general announcements spilled over across different areas and were perceived by home-country banks as subsidies boosting the competitive advantage of foreign banks. Specific announcements produced effects that were consistent with other banks being crowded out for government resources. Multiple specific announcements exacerbated the extent of banks’ moral hazard. Results were sensitive to the information environment. Findings are consistent with the hypothesis that individual institutions were reluctant to seek public assistance.

The Gravity Equation in International Economics and International Business Research: A Note

This note discusses methodological issues and practical concerns for international economists and international business scholars who apply the gravity equation in their research. The most important message of the note is that this equation should correct for multilateral resistance factors. We propose a relatively low-cost specification and estimation to implement such correction, which is robust in the presence of various endogeneity effects and non-stationary variables. In the presence of zero-values in the dataset, however, the multilateral specification is best estimated with a Poisson maximum likelihood.