Gravity in Transition

ABSTRACT We propose a reduced‐form transitional gravity model and an accompanying flexible reduced‐form estimation approach. The Lucas–Prescott adjustment model is extended to allow for lag‐interval‐varying depreciation‐ cum ‐adjustment‐cost of bilateral trade capacities. The resulting lag‐interval‐varying trade elasticities vary from 0.4 in the short run to 4.8 in the long run. Long‐run equilibrium is reached in about 14–15 years. The model rationalizes trade elasticities that are less than one and offers a potential solution to the ‘international elasticity puzzle’–the discrepancy between trade elasticities from the trade and macro literatures. Theories of dynamic adjustment in trade costs are supported, and phasing‐in effects of FTAs are explained.