internationally, a change in international trade costs a¤ects a proportionately smaller subset of their total production. Accordingly, their price indices, and hence multilateral resistance, change by less. MR therefore provides a smaller dampening e¤ect on bilateral trade elasticities, such that the overall elasticity net of MR is larger. Conversely, smaller countries will have smaller elasticities net of MR. Given the skewness in the world’s distribution of country size, most countries are small. Therefore, standard estimates overstate the impact of changes in logistics on bilateral trade ‡ows for most countries. Conversely, for a handful of large developing countries, the impact is underestimated.

The second issue was addressed by Helpman, Melitz & Rubinstein (2008), who develop a method to account for the consequences of heterogeneous ...rm productivity in gravity models. Firm heterogeneity gives rise to two margins of adjustment to changes in trade barriers: the intensive margin, which captures exports per ...rm, and the extensive margin, which captures the number of exporting ...rms. If ...xed trade costs are su¢ ciently high, no ...rms in a given country may export to a particular destination, which explains the zeros observed in aggregate trade data. These issues a¤ect estimation and ignoring the e¤ects of trade costs on ...rm entry results in misleading country-level comparative statics even if the countries do trade.

Behar & Nelson (2009) develop a model which accommodates both MR and ...rm heterogeneity. They demonstrate the importance of these e¤ects for comparative statics when trade costs are captured by bilateral distance. In this paper, we adapt that approach to the case of logistics. Unlike distance, logistics might not be exogenous, so we take potential endogeneity seriously. Further, unlike bilateral distance, the logistics index is a country-speci...c variable which precludes the use of ...xed e¤ects to control for MR in estimation. Instead, we proxy MR terms using an adaptation of Baier & Bergstrand’s (2009) method. Our approach allows us to implement this method together with Helpman, Melitz & Rubinstein’s procedure to account for ...rm heterogeneity. While the application in this paper is to logistics, the implications fall on a wide class of country-speci...c international trade costs.

Section 2 provides an overview of the existing literature on logistics and international trade before expanding on the importance of MR and the selection issues associated with ...rm heterogeneity. Section 3 describes the data. The World Bank constructed its logistics performance index (LPI) using a principal component analysis of six indicators. We describe those indicators and describe how we extract only those that are relevant to international trade (as opposed to within-country trade) to produce what we call the International Logistics Index (ILI).

Section 4 formalizes our gravity modelling framework, which accounts for both ...rm heterogeneity and MR, and derives the Baier & Bergstrand (2009) approximation for country-speci...c trade costs in this context. In deriving the full comparative statics that take account of MR, this section illuminates how the trade impact varies with country size. Section 5 discusses estimation issues. Because trade ‡ows may a¤ect investments in logistics, logistics may be an endogenous regressor. To deal with this, 3