Revisiting McCallum's Border Puzzle

The "border effect" in international trade refers to a situation in which there is higher volume of trade within a country compared with the volume of trade across the country's borders. Although trade economists are not surprised at the existence of a border effect, they do find the significant size of the estimated effect in the empirical literature perplexing. In this study we authors show why previous empirical studies have had an upwards bias in the estimation of the border effect. The study also provides more reasonable estimates of McCallum's estimated border effect in United States-Canada trade.