This paper provides insights into the relevance of the appropriate estimator choice for the analysis of bilateral trade flows. I compare different estimators part of which have been used in previous studies and provide insights that none of the previously used estimators is appropriate in terms of consistency and/or efficiency in my application. I argue that three problems should be kept in mind when estimating gravity models and/or calculating trade potentials. First, traditionally estimated time-averaged cross-section gravity models are very likely to be misspecified since they ignore the presence of exporter and importer effects without testing for their relevance. Second, one should be careful with comparing estimation results between different econometric concepts, which refer to different time horizons with respect to responses of trade flows on changes in the explanatory variables. Third and in contrast to previous research, I do not see any way to derive information about so-called trade potentials of the in-sample prediction approach. Rather, I suggest that any large systematic difference between observed and in-sample predicted trade flows indicates misspecification of the econometric model instead of unused (or overused) trade potentials. In the present application, the consistent and efficient model is a Hausman and Taylor AR(1) estimator, which has never been used before. According to econometric theory, which demands for white-noise residuals in the case of proper (i.e. consistent and efficient) specification, this estimator fails to identify large systematic differences between residuals among country groups. Large unused in-sample export potentials, which have been identified previously in the context of European integration reveal nothing other than inherent problems of misspecification in terms of consistency and efficiency of the estimators and the econometric models in use. Nevertheless, the gravity model remains a useful tool for counterfactual simulation analysis. Future applications could focus on simulations of changes in the explanatory variables such as convergence in terms of GDP per capita or trade cost reductions.
