IEB_GRP4_The Gravity Model Specification for Modeling International Trade Flows

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8/2/2019 IEB_GRP4_The Gravity Model Specification for Modeling International Trade Flows

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3/18/12

The Gravity Model Specification forModelling International Trade Flows andFree Trade Agreement Effects: A 10-YearReview of Empirical Studies

Konstantinos Kepaptsoglou, Matthew G. Karlaftis and DimitriosTsamboulas

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FLOW OF PRESENTATION

§ Objective of the paper

§ Introduction GRAVITY MODEL OF TRADE

§ Framework GRAVITY MODEL OF TRADE

§ Parameters GRAVITY MODEL OF TRADE

§ Methodological Aspects

§ Empirical Findings

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ü To provide a systematic review of recent work on

trade flow modelling from an empirical perspectiveoffering a basis for evaluating current research

ü To provide insights on the effects of FTAs on trade asexplained by gravity model specifications

ü To provide an overview of the different modelling

approaches for explaining trade flows

ü To present the gravity model and proposing aframework for categorizing existing studies

OBJECTIVE OF THE PAPER

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The GRAVITY MODEL is an empirical model that

follows from the equation of gravitational attractionproposed in Newtonian Mechanics.

GRAVITY MODEL OF TRADE

§ F: Force of gravitational

attraction§ m1: mass of body 1

§ m2: mass of body 2

§ r: distance between them

§ G: Gravitational Constant

PHYSICS TRADE

§ T12: Force of

gravitational attraction§ GDP1: mass of body 1

§ GDP2:mass of body 2

§ d: distance between them

§ C12: constant

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Volume of trade can beestimated as:

§ An increasing function of the national incomes of

trading partners

§ A decreasing function of

the distance between them

GRAVITY MODEL OF TRADE

§ The constant ( C12) is not predetermined

§ This constant varies for each pair of economies and it has to be estimated througha regression analysis which fits historical trade

data to the historical GDPs of the economies in

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• Introduced by Tinbergen and Linneman (1966)

• Widely used for explaining flows of International

• To explain and predict the effects of Free Trade

Agreements on trade flows

• Strength: considerable empirical robustness and

GRAVITY MODEL OF TRADEContd….

CountryB

Country

ADistance

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A THREE LAYER FRAMEWORK

A three layer framework is proposedfor organizing studies related to gravitybased 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 5years

• Only few recent studies draw conclusions based on CROSS-SECTIONAL DATA based on a single year or an average of aperiod.

CROSS SECTIONAL DATA

§ Cross-sectional data in statistics and econometrics is a type of one-

dimensional data 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.

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PARAMETERS: DATASETS

PANEL DATA

§ Multi-dimensional data.

§ It contains observations on multiple phenomena observed over

multiple time periods for the same firms or individuals.

§ Cross-sectional data is a special case of panel data that is in

one-dimension only

EXAMPLEBalanced panel Unbalanced panel

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DEPENDANTVARIABLES

Exports and bilateral trade flows arethe most common dependent variables

found in trade flow gravity models• EXPLORATORYVARIABLES

Explanatory variables can be

distinguished in the following twogroups:

§ Factors indicating demand and supply of tradingcountries

§ Factors representing the impedance imposed on a

PARAMETERS:DEPENDANT AND

EXPLORATORY VARIABLES

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– Factors indicating demand andsupply of trading countries

Examples:

Measures of a country’s economic andmarket size

• Income level

Population• Area size

• GDP per capita

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– Impedance Factors

All those elements that affect trade flows in anegative or positive manner. Transportationcosts 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 usualtechnique for estimating the coefficientsof the gravity model specification in its

log linear form.

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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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ORDINARY LEAST SQUARE (OLS) METHOD

ü It is a method for estimating the unknown parameters in

a linear regression model.

ü This method minimizes the sum of squared vertical distances

between the observed responses in the dataset and the

responses predicted by the linear approximation.

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q With over 55 papers published within the last decade, the gravitymodel has been established as a major instrument for analyzing

trade flows and explaining effects of related trade agreements.

q Despite earlier criticism, the research community has madeefforts both in improving the model’s theoretical foundation and

adopted novel econometric methods for estimating itsparameters with more accuracy.

q Panel data sets are preferred over Cross sectional models

q GDP, GDP per capita and distance are the most commonexploratory variables

q Distance is always encountered as impedance variable

EMPHERICAL FINDINGS

FREE TRADE AGREEMENTS

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The aim of FTAs is to increase tradebetween two countries as a result of relaxing or removing existing

institutional and economic barriers

Free Trade Agreementsare forms of trade pactsbetween countries;these agreementseliminate tariffs, quotasand other barriers for anumber of goods (if not

for all),traded betweeninvolved partners.

FREE TRADE AGREEMENTS

A EXAMPLE f EMPHERICAL

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An EXAMPLE of EMPHERICALSTUDY

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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 tradeof Greece: an appraisal of the evidence. Appl Econ2000; 32(2): 151-9.

§ ejas-iimb.org/articles/57.php

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IEB_GRP4_The Gravity Model Specification for Modeling International Trade Flows

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