The Impact of Oil Prices on Trade

Abstract

This paper introduces an oil price–distance interaction variable in a gravity equation to explain how global trade behaves as a result of oil price changes. The findings are that as oil prices increase, international trade becomes more localized in that countries begin trading relatively more with their neighbors. In contrast, when they decrease, trade becomes more dispersed in that the distance between countries becomes less relevant. These results are highly significant across specifications, and the magnitude is not to be ignored. According to the full specification an oil price halving will make trade more dispersed by relatively increasing trade by 40% for a distance of 10,000 miles and by 25% for a distance of 1,000 miles.