Specialization, Gravity, and European Trade in Final Goods

Abstract

By combining and extending the previous literature, we develop and test a gravity specification that views bilateral gravity equations rooted in a Heckscher-Ohlin framework as statistical relationships constrained on countries’ multilateral specialization patterns. According to our results, Heckscher-Ohlin specialization incentives do not seem to play much of a role in the average European bilateral final goods trade relationship. However, this aggregate view conceals that trade in final goods between Western and Eastern Europe is driven by countries’ multilateral specialization incentives, as expressed by supply-side country differences relative to the rest of the world, fully compatible with the incomplete specialization version of Heckscher-Ohlin. This indicates that many of the final goods traded between Western and Eastern Europe are still different, rather than differentiated, products.