Distance as a determinant of trade costs: a different type of distance puzzle?

Employing a gravity model approach to examine the determinants of annual bilateral trade costs for the period 1995–2018, we present evidence of a novel “trade cost-distance puzzle.” Previous studies have identified the existence of a traditional “distance puzzle”, sometimes referred to as the “missing globalization puzzle”, that notes an increasingly negative influence of distance on bilateral trade flows across time periods. This paper extends the traditional “distance puzzle” from the trade costs perspective. After controlling for variables widely considered as determinants of trade costs, we demonstrate that while distance, as expected, is positively related to trade costs, the influence of distance on trade costs increases over time. This finding is contrary to the intuition regarding the effects of globalization on international trade. As a second contribution, we propose a partial solution to the puzzle. Applying the Poisson pseudo-maximum likelihood (PPML) estimation technique to balanced panel data sets resolves the puzzle for total trade costs and manufacturing trade costs; however, the puzzle persists for agricultural trade costs.