Trade costs in empirical New Economic Geography

Trade costs are a crucial element of New Economic Geography (NEG) models. Without trade costs there is no role for geography. In empirical NEG studies the unavailability of direct trade cost data calls for the need to approximate these trade costs by introducing a trade cost function. In doing so, hardly any attention is paid to the (implicit) assumptions and empirical consequences of the particular trade cost function used. Based on a meta-analysis of NEG market access studies as well as on the results of estimating the NEG wage equation for a uniform sample while using different trade costs functions, we show that the relevance of the key NEG variable, market access, depends nontrivially on the choice of trade cost function. Next, we propose an alternative way to approximate trade costs that does not require the specification of a trade cost function, the so called implied trade costs approach. Overall, our results stress that the specification of trade costs can matter a lot for the conclusions reached in any empirical NEG study. We therefore call for a much more careful treatment of trade costs in future empirical NEG studies.