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Day1 S2 Gravity Intro

The document summarizes an introduction to the basic gravity model presented during a capacity building workshop. It provides an overview of what the gravity model is, where it originated from, how it relates trade flows to economic masses and trade costs, and examples of how it has been applied to study factors affecting international trade. The gravity model has become a widely used and robust tool to quantitatively assess the impacts of various trade policies on bilateral trade flows using real trade data.

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Pedro Hortua Segura
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128 views

Day1 S2 Gravity Intro

The document summarizes an introduction to the basic gravity model presented during a capacity building workshop. It provides an overview of what the gravity model is, where it originated from, how it relates trade flows to economic masses and trade costs, and examples of how it has been applied to study factors affecting international trade. The gravity model has become a widely used and robust tool to quantitatively assess the impacts of various trade policies on bilateral trade flows using real trade data.

Uploaded by

Pedro Hortua Segura
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ARTNeT- GIZ Capacity Building Workshop on Introduction to Gravity Modelling:

19-21 April 2016, Ulaanbaatar

Session 2: Introduction to the basic gravity model

Dr. Witada Anukoonwattaka


Trade and Investment Division, ESCAP
[email protected]

1
Introduction
• Gravity model is a very popular econometric model in
international trade
• Origins with Tinbergen (1962). Thousands of published
articles and working papers since then.
– “Some of the clearest and most robust findings in empirical
economics.” (Leamer & Levinsohn, 1995)

• The name came from its utilizing the gravitational force


concept as an analogy to explain the volume of bilateral trade
flows

• Initially, it was not based on theoretical model, but just


intuition only

• Later on, a range of rigorous theoretical foundation has been


given.
2
Introduction
• Gravity’s main comparative advantage lies in its ability to use
real data to assess the sensitivity of trade flows with respect
to policy factors we are interested in.
• Numerous applications looking at different types of factors
affecting trade costs, and their impacts on trade flows:
– Transport costs.
– Tariffs and non-tariff barriers.
– Regional integration agreements, currency unions, and the
– GATT/WTO.
– Time delays at export/import and trade facilitation.
– Governance, corruption, and contract enforcement.

3
Introduction
• In recent years, intuition is not enough.
• Gravity models have become a complex business: back to
microfoundations!
– Different microfoundations imply different estimation techniques.
– Use of sectorally disaggregated data, and broad country samples,
brings out new issues for theory and empirics.
• To do good applied/policy research, it is important to be on
top of the latest developments in the literature.

4
The traditional gravity model

5
• Concepts and stylized facts of the gravity
approach
• Example of applications
• Identifying (“trade potentials”) using gravity
approach

6
Gravity force in Physics

MiM j
Fij  G
d ij2

7
Gravity Analogy
Gravity force equation Intuitive gravity for trade
Yi Y j
X ij  C
tij
MiM j
Fij  G X ij  exports (or trade) from i to j ,
2
D ij
C  contstant,
Gravity force between two
objects depends on their Y  economic mass ( GDP),
masses and inversely t  trade costs between two countries
proportional to the square of
distance between them.  distance, adjacency, .., " policy factors".

Export (or trade) between two countries


depends on their economic masses and
negatively related to trade costs between
them.
8
Trade and combined GDP
gen ln_gdp_both = ln(gdp_exp*gdp_imp)

twoway (scatter ln_trade ln_gdp_both) (lfit ln_trade ln_gdp_both)

Based on AP export data 2013 provided in WITS 9


Trade and distance
twoway (scatter ln_trade ln_distance) (lfit ln_trade ln_distance)

Based on AP export data 2013 provided in WITS

10
What is the gravity model?
• Gravity model is a very popular econometric model in
international trade

• The name came from its utilizing the gravitational force


concept as an analogy to explain the volume of bilateral trade
flows
– Proposed by Tinbergen (1962)

• Initially, it was not based on theoretical model, but just


intuition only

• Later on, a range of rigorous theoretical foundation has been


given.
– The most well-known benchmark so far is Anderson and van Wincoop
(2003).
11
Intuitive gravity model of trade:
Yi Y j
X ij  C
tij

• Larger countries trade more than smaller ones


• Trade costs between two trade partners reduce trade
between them.

Empirical equation for basic gravity model:

ln X ij  b0  b1 ln(Yi )  b2 ln(Y j )  b3 ln(t ij )  eij


b1 , b2  0; b3  0
A 1% change in Yi is associated with a b1 % chage in X ij .
12
Proxies for trade costs
• Distance
• Adjacency
• Common language
• Colonial links
• Common currency
• Island, landlocked
• Institutions, infrastructures, migration flows,..
• Bilateral tariff barriers

13
Why is it so popular?
• Intuitively appealing
• Fits with some important stylized facts
• Easily to use real data to explain trade flows with respect to
policy factors.
• Estimation using OLS

14
Applications of gravity models

• Analysis of elasticities of trade volumes


- Regional Trade Agreements (RTA), "natural regionalism" (Frankel & Wei,
1993, Baier & Bergstrand 2005)
- WTO membership
- Impact of NTBs on trade (Fontagné et al. 2005)
- Cost of the border (Mac Callum, Anderson & van Wincoop 2003)
- Impact of conflicts on trade
- FDI & trade: complements or substitute (Eaton & Tamura, 1994; Fontagné,
2000)
- Effect of single currency on trade (Rose, 2000)
- Trade patterns: inter and intra-industry trade (Fontagné, Freudenberg &
Péridy, 1998)
- Diasporas (community of immigrants)
- Internet
Applications of gravity models

• Analyse predicted trade flows and observe


differences between predicted and observed flows
(analysis of residuals)
- Trade potentials of economies in transition (out-of sample
predictions)
- Identify the natural markets and markets with an untapped
trade potential
- Predicted values are used in some cases as an input for CGE
modeling (Kuiper and van Tongeren, 2006)
- Use of confidence intervals in addition to predicted values,
in order to take into account the residual variance
Examples of Applications
• Effects of regional integration on trade

Do RTAs boost trade between members?


ln X ij  b0  b1 ln(Yi )  b2 ln(Y j )  b3 ln(tij )  b4 (dummyRTAij )  eij

Do RTAs reduce exports from non - members?


ln X ij  b0  b1 ln(Yi )  b2 ln(Y j )  b3 ln(tij )  ...
 b4 (dummy BothInRTAij )  b5 (dummy OneInRTAij )  eij
• By using dummy variables, gravity models provide a crude measure of RTA
impact on trade but cannot distinguish the precise mechanisms.
• Both b4 > 0 and b5>0 implies trade creating RTA.
• Only b4> 0 while b5<0 implies trade diverting RTA
See, World Bank (2005) for survey.
17
• Two important limitations related to using gravity models for estimating
the impact of a RTA:
1. RTAs may be endogenous variables (ie. the causal link between the
formation of a RTA and trade flows). This endogeneity affects gravity-
based estimates.
2. Recent literature is replete with models in which regional integration
agreements are formed in the pursuit of other, non-trade goals (see, for
instance, Limao, 2006) or in which they have “non-traditional” gains (see
Ethier, 1998).
– South–South agreements have been rather more successful in non-trade dimensions
like the management of common resources than in the dimension of pure trade-
liberalization.
• The analysis of RTAs should avoid limiting itself to measuring trade
diversion and creation, although these are important issues for the
welfare of member countries.

18
Examples of Applications
• Effects of institutional weakness on trade
How does corruption affect trade?
ln X ij  b0  b1 ln(Yi )  b2 ln(Y j )  b3 ln(tij )  b4 ln(corruptioni )  eij

Anderson and Marcouiller use a 58-country gravity model and corruption data
from the World Economic Forum to show that:
• Institutional weaknesses, generally corruption and lack of contract
enforceability, have a significant negative impact on trade.
• If Latin America increased measured institutional quality to the same level
as the EU, their trade would increase by about 30%: about the same as
with a major tariff cut.

19
Examples of Applications
• Effects of trade facilitation on trade
How much can trade facilitation boost bilateral trade?
ln X ij  b0  b1 ln(Yi )  b2 ln(Y j )  b3 ln( d ij )  b4 ln(timeiX )  eij
• Djankov Freund & Pham (2010) use a gravity model with Doing Business
data on border crossing times (98 countries) to show that:
– Slower border crossing times can significantly reduce bilateral trade:
One extra day reduces exports by 1%.
– Time-critical agricultural and manufactured goods are particularly
sensitive to border crossing times:
• Agriculture: Fresh fruits and vegetables.
• Manufactures: Electronic goods; parts and components.
• Landlocked countries are particularly sensitive to border crossing times:
One extra day reduces exports by as much as 4%.

20
Examples of Applications for landlocked countries

• Effects of being landlocked countries on trade


How much does being lancdlocked reduce trade?
ln X ij  b0  b1 ln(Yi )  b2 ln(Y j )  b3 ln(d ij )  b4 ln(landlockedij )  ...  eij
Raballand (2003) applies a gravity approach to (46 countries of which 18 are
landlocked) show that being landlocked country would reduce trade by 80%
(when measured by a dummy variable).
• Determinants of trade costs
An example of trade-cost regressions, (See, Moïsé and Sorescu, 2013, etc.)

Without
landlocked

With landlocked

21

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