More on the Gravity model of trade

A presentation by Dr. Ramon Clarete of UPSE during the UPSE-Ayala forum early this year was entitled “Going Regional: Which Mega Trade Deals Should the Philippines Join?

He used the Gravity model of trade in estimating the level of bilateral exports or imports between two trading partners. So the dependent variable is the flow of trade between and among countries studied, the independent or explanatory variables are the following and their expected signs or relationships:

GDP (+), population (+), distance between two countries (-), commonality of language (+), shared borders (+), landlocked state (-).

In addition, Trans Pacific Partnership (TPP), Regional Comprehensive Economic Partnership (RCEP) indicators or dummy variables are introduced:

TB1, 1 if both trading countries are TPP or RCEP members, 0 otherwise,

TB2, 1 if exporting country is a TPP or RCEP member, 0 otherwise,

TB3, 1 if importing country is a TPP or RCEP member, 0 otherwise.

For overlapping memberships, a dummy variable where TPP*RCEP =1 if both trading partners are members of the two trade blocs.

Some 209 trading countries and their annual trade data from 1948 to 2013 was used and analyzed.

gravity3A time interaction variable, 1 after 1990s (representing more or less the fact that China has become integrated with the world economy).

Here is the result. All estimated coefficients are statistically significant and bear the expected signs.

In particular, these coefficients mean that…

gravity1

The implied change of exports of membership are shown below. If the Philippines, already a member of RCEP, and it further becomes a TPP member, its exports are expected to rise by 48%, and real GDP projected to rise by 61%.

gravity2

Meanwhile, a paper produced February 2015 (39 pages), Trade Theory Network, by Michael Hubler, Four theoretical examples with numerical applications are presented, below:

* increase in trade from Asia to North America affects the world economy,

* an intuitive rule for finding the welfare-optimal tariff is derived,

* three possibilities for vanishing trade effects (fluctuations) are explained: trade diversion, the “river-island effect”, and overlapping business cycles. Fourth, it is shown how adjustment costs delay the propagation of shocks or business cycles.

Among the results are as follows:

A reduction in TPP trade barriers is welfare-improving for North America and Asia. This result corroborates plans for trans-Pacific free trade agreements. The paper has shown that a moderate increase in trans-Pacific trade has significant repercussions on the world economy…. Moreover, the paper has shown that halving the trade barrier between Europe and Asia could create a situation in which the rest of the world, in particular Africa, is to some extent protected from shocks affecting international goods markets.

Less trade barriers, less regualtions and permits, mean higher trade flows and economic growth.

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