'Linguistic distance' as a determinant of bilateral trade.

• Author: Hutchinson, William K.

1. Introduction

   Variables accounting for the transaction costs associated with international trade have been included in gravity models since the early application of this model to explain the volume of bilateral international trade. (1) Although Bergstrand (1985, 1989) limits transaction cost variables to adjacency and membership in a preferential trading area, Gould (1994) extends Bergstrand (1985) to explicitly model "costs associated with gaining foreign market information." Gould focuses on the trade-enhancing effects arising from the presence of a stock of foreign immigrants residing in the home country.

   Several papers have extended Gould (1994) and all of these have included a variable to account for the effect that a common language between the trading partners would have on transactions costs. (2) Frankel (1997) discusses the role of common language in the gravity framework and has included this variable in subsequent papers. (3) Boisso and Ferrantino (1997) attempt to capture the language effect by constructing a measure of the likelihood that an exporter from one country would encounter an importer in another country who spoke the same language. Their measure of linguistic similarity had no identifiable effect on the volume of trade between pairs of countries. That is, a higher probability that an exporter from one country would encounter an importer in a second country who spoke the same language had no significant effect on the volume of trade between the two countries.

   Wagner, Head, and Ries (2002) attempt to provide a measure of the degree of commonality of language between two countries that is very similar to that derived by Boisso and Ferrantino; that is, it is the probability that a randomly chosen person from a Canadian province would speak the same language as a randomly chosen person in the trading partner. These measures are a modification of the practice of using a dummy variable for a common language between trading partners. Hutchinson (2002) demonstrates that the greater the proportion of the population that speaks English as either a first or a second language, the higher the volume of trade (both exports and imports) between the United States and that country. (4)

   We attempt to capture the trade effect imposed on residents of a country, native or immigrant, of learning a second language. We examine the effect on international trade that results from what Chiswick and Miller (1998) call "linguistic distance": how "distant" from English a particular language is, in the sense of how difficult it is to learn the foreign language. With the use of a measure of the relative difficulty that a native English-speaking person encounters in learning particular languages, (5) Chiswick and Miller (1998) studied the effect of linguistic distance on English language fluency for immigrants in the United States. Fluency in English is a determining factor in the ability of an immigrant to realize the potential benefits from networking and to effectively use knowledge of their home country tastes and markets to promote trade and commerce between their host country and their country of origin. Thus, in addition to all the other factors that affect the volume of bilateral trade, linguistic distance is hypothesized to affect the volume of bilateral trade by increasing transaction costs and reducing the volume of trade between the United States and trading partners.

   Greater difficulty in attaining English language fluency diminishes the ability of residents of foreign countries to develop networks and take advantage of specific knowledge of their home country tastes and markets in promoting trade with the United States. Similarly, the greater the difficulty for a native English speaker to become fluent in a foreign language, the lower will be the volume of trade one would expect to observe between the United States and the country in which the foreign language is spoken. Both effects work in the same direction: the greater difficulty a native English speaker (non-English speaker) has in obtaining fluency in a foreign language (English), the lower the volume of bilateral trade one expects to find between the United States and the country in which the particular foreign language is spoken.

   This paper will proceed in the following manner. In the next section we present the model and discuss the data in section 3. Empirical results are presented and discussed in section 4, and these results are related to the trade literature in the final section.

2. Model

   We need a model that, controlling for other determinants of trade, will allow us to determine the effect that linguistic distance has on the volume of trade. We use a gravity model based on Gould (1994) which was an extension of Bergstrand (1985). Gould introduces transaction costs into the model. He argues that these costs arise from the lack of knowledge that a person from one country has regarding the laws, customs, tastes and riskiness of markets in another country. Gould attempts to model the effect that a stock of immigrants from a country will have on the cost of obtaining such information. Obtaining such information will result in larger trade volumes between the host country and the immigrant's country of origin. We argue that independent of the effect of immigrants on trade flows, the difficulty of obtaining information and conducting trade depends on the difficulty of learning the foreign country's language as well as the difficulty for someone from the foreign country learning the home country's language. We measure this degree of difficulty with the Chiswick and Miller index discussed in the previous section.

   Gould's model assumes identical technologies among N countries that produce products differentiated by country of destination. In the supply side of the model, labor is allocated across industries for each country according to a constant elasticity of transformation technology. Labor is transformed at constant elasticity, but the rate is different when labor is transformed between foreign products than when labor is transformed between foreign and domestic products. Transactions costs are introduced as a wedge between the price that a good sells for in a foreign market and the price that the domestic producer receives for the good. Gould models three types of transaction costs: tariffs and other trade barriers, transport costs, and information costs. As Equation 1 describes, the price received, [P.sup.*.sub.ij], by i for selling a product in the jth market is less than the price the product sells for in the foreign market, [P.sub.ij], because of these three types of transaction costs. The greater the transactions costs, the lower the supply of goods to foreign markets. We shall return to these costs in a moment.

   [P.sup.*.sub.ij] = [P.sub.ij]/[T.sub.ij][C.sub.ij][Z.sub.ij] (1)

   Consumers in all countries have the same constant elasticity of substitution utility function in which the elasticity of substitution differs when comparing foreign and domestic goods as opposed to comparing two foreign goods. There are N(N - 1) import demand equations to match the N(N - 1) export supply functions, which allows one to solve for equilibrium conditions. Assuming that countries are small allows one to derive price and trade flow quantity equations, which when multiplied yield value of aggregate trade flow equations. The value of aggregate trade flows is described in Equation 2, in which trade flows are determined by country incomes ([Y.sub.i], [Y.sub.j]), transactions costs ([C.sub.ij], [T.sub.ij], (6) and [Z.sub.ij]), export prices ([P.sub.ij]), import prices ([P.sup.*.sub.ij]), a domestic price index ([P.sup.*.sub.ij] + [P.sub.ii]), and a foreign price index ([P.sub.ij] + [P.sub.jj]). (7)

   [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (2)

   Gould offers a specific formulation for Z to capture the information effect of a stock of immigrants, which, as Wagner, Head, and Ries (2002) point out, is not derived from theory. (8) We offer an alternative formulation that we believe captures the essence of the effects one would attribute to the presence of immigrants as well as the language difficulty encountered when attempting to take advantage of specific information about tastes, culture, laws, and market risk. We model [Z.sub.ij] as described in Equation 3, where [M.sub.ij] is the stock of immigrants in country i from country j and [ld.sub.ij] is the index of the difficulty for a person whose native tongue is the language of country i to learn the language of country j. This specification captures the positive trade effect resulting from a stock of immigrants and the negative effect resulting from greater difficulty in learning the foreign language.

   Z = [ld.sub.ij]/[M.sub.ij] [[differential]X/[differential]M] > 0 [[differential]X/[differential]ld]

   The advantage of specifying the model as in Equations 1, 2, and 3 is that it can be estimated in the standard double logarithmic form that is typically used for the gravity model. Use of the double logarithmic specification facilitates comparison with the results of other investigators who have examined trade in the gravity framework.

   Gould used a country fixed effects model to determine how important the presence of a stock of immigrants was for trade between the United States and the home country of the immigrants. To determine the effect of linguistic distance, we cannot use a country fixed effects model because, unlike the stock of immigrants, linguistic distance is fixed for a country. Therefore, in addition to the linguistic distance index, we include the standard country-specific gravity model variable, distance. Distance, as measured by the great circle distances between national capitals, will be used as a proxy for transport cost. (9) We also include a time trend to control for possible bias introduced by growth over time in the size of trade and income. (10)

   The gravity model...