The Gravity Model Specification for Modelling International Trade Flows and Free Trade Agreement Effects: A 10-Year

Review of Empirical Studies

Konstantinos Kepaptsoglou, Matthew G. Karlaftis and Dimitrios 3/18/12 Tsamboulas

FLOW OF PRESENTATION

Objective of the paper Introduction GRAVITY MODEL OF TRADE Framework GRAVITY MODEL OF TRADE Parameters GRAVITY MODEL OF TRADE Methodological Aspects
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OBJECTIVE OF THE PAPER

To provide a systematic review of recent work on trade flow modelling from an empirical perspective offering a basis for evaluating current research To provide insights on the effects of FTAs on trade as explained by gravity model specifications To provide an overview of the different modelling approaches for explaining trade flows To present the gravity model and proposing a framework for categorizing existing studies
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GRAVITY MODEL OF TRADE

The GRAVITY MODEL is an empirical model that follows from the equation of gravitational attraction proposed in Newtonian Mechanics.

PHYSICS

TRADE

F: Force of gravitational attraction m1: m2: mass of body 1 mass of body 2

r: distance between them

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T12: Force of gravitational attraction GDP1: mass of body 1 GDP2:mass of body 2 d: distance between them C12: constant

GRAVITY MODEL OF TRADE

Volume of trade can be estimated as:

An increasing function of the national incomes of trading partners A decreasing function of the distance between them

The constant ( C12) is not predetermined

This constant varies for each pair of economies and it has to be estimated through a regression analysis which fits historical trade data 3/18/12 to the historical GDPs of the economies in

GRAVITY MODEL OF TRADE Contd. Country

Distan ce
Country B

Introduced by Tinbergen and Linneman (1966) Widely used for explaining flows of International trade

To explain and predict the effects of Free Trade Agreements on trade flows

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Strength: considerable empirical robustness and

A THREE LAYER FRAMEWORK

A three layer framework is proposed for organizing studies related to gravity based trade flow modelling

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A THREE LAYER FRAMEWORK

LAYERS

PROPERTIES

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PARAMETERS: DATASETS

PANEL DATA are used in most studies for periods of at least 5 years

Only few recent studies draw conclusions based on CROSSSECTIONAL DATA based on a single year or an average of a period. CROSS SECTIONAL DATA

Cross-sectional datainstatisticsandeconometricsis a type of onedimensionaldata set.

It refers to data collected by observing many subjects (such as individuals, firms or countries/regions) at the same point of time, or without regard to differences in time. 3/18/12

PARAMETERS: DATASETS
PANEL DATA

Multi-dimensionaldata. It contains observations on multiple phenomena observed over

EXAMPLE

Balanced panel Unbalanced panel multiple time periods for the same firms or individuals.

Cross-sectionaldata is a special case of panel data that is in one-dimension only

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VARIABLES Exports and bilateral trade flows are the most common dependent variables found in trade flow gravity models EXPLORATORY VARIABLES Explanatory variables can be distinguished in the following two groups:

PARAMETERS: DEPENDANT AND DEPENDANT EXPLORATORY VARIABLES

Factors indicating demand and supply of trading countries Factors representing the impedance imposed on a

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Factors indicating demand and supply of trading countries

Examples:

Measures of a countrys economic and market size Income level Population Area size GDP per capita
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Impedance Factors

All those elements that affect trade flows in a negative or positive manner. Transportation costs are the main resistance factors; These include:

Actual freight transportation costs tariffs quality of infrastructure, etc.

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METHODOLOGICAL ASPECTS
The Ordinary Least Squares (OLS) method has been traditionally the usual technique for estimating the coefficients of the gravity model specification in its log linear form.

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METHODOLOGICAL ASPECTS
LOG LINEAR FORM OF GRAVITY MODEL

Consider a flow of goods Fij between two areas i and j. Fij can then be expressed as a function of the characteristics of the origin (Oi) and the destination (Dj) areas and some measure of impedance between them (Rij):

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METHODOLOGICAL ASPECTS
ORDINARY LEAST SQUARE (OLS) METHOD

Itis a method for estimating the unknown parameters in alinear regression model.

This method minimizes the sum of squared vertical distances between the observed responses in thedatasetand the responses predicted by the linear approximation.

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EMPHERICAL FINDINGS
q

With over 55 papers published within the last decade, the gravity model has been established as a major instrument for analyzing trade flows and explaining effects of related trade agreements.

Despite earlier criticism, the research community has made efforts both in improving the models theoretical foundation and adopted novel econometric methods for estimating its parameters with more accuracy.

Panel data sets are preferred over Cross sectional models

GDP, GDP per capita and distance are the most common exploratory variables
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Distance is always encountered as impedance variable

FREE TRADE AGREEMENTS

Free Trade Agreements are forms of trade pacts between countries; these agreements eliminate tariffs, quotas and other barriers for a number of goods (if not for all),traded between The aim of FTAs is to increase trade involved as a result of between two countries partners. relaxing or removing existing institutional and economic barriers 3/18/12

An EXAMPLE of EMPHERICAL STUDY

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REFERENCES

Linneman H. An econometric study of world trade flows. Amsterdam: North-Holland Publishing Co. 1966. http://info.worldbank.org Arghyrou MG. EU participation and the external trade of Greece: an appraisal of the evidence. Appl Econ 2000; 32(2): 151-9. ejas-iimb.org/articles/57.php
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