GRAVITY EQUATION AND TRADE AGREEMENTS: A DIFFERENT ECONOMETRIC APPROACH

RECALDE, MARÍA LUISA; FLORENSA, MARCELO; ITURRALDE, IVAN

San Pablo

Seminario; Arnoldshain Seminar VIII; 2008

Universidad de San Pablo

The gravity equation model applied to international trade is based on the assumption that trade between two countries is directly related to their size (generally measured by the national product and the population) and inversely to the transaction costs (distance, adjacency, language in common). It has been widely used to assess the effects of trade agreements due to its advantage on the capability of isolating the effects of other factors which also explain international trade. The empirical application of the gravity model has been performed through cross-section data, panel data, pool, etc. Studies on the theoretical fundamentals of this model affirm that it is not possible to say that the gravity equation responds to a particular international trade model, Anderson (1979), Bergstrand (1985, 1989), Helpman and Krugman (1985), Deardoff (1995), Evenett and Keller (1998) and Anderson and Mercoullier (1999). Putting aside the features which have to do with its theoretical fundamentals, the empirical success of the gravity equation is based on its ability to incorporate most of the phenomena that occur in international trade: increasing trade volume among industrialised countries, intra-industry trade, trade liberalisation adjustments, relation between the country size and its exports, etc., Sá Porto (2002). In the case of MERCOSUR, diverse articles have analysed different features: sectoral exports and distance, are studied in Martínez Zarzoso et al. (2002); trade flows determinants Martínez Zarzoso et al. (2003) and openness and trade liberalisation in Azevedo (2001) and Carrillo and Li (2002). The effects of MERCOSUR on Argentina is analysed in Recalde and Florensa (2005a), which aims at dynamically assessing the impact on agricultural products trade and Recalde and Florensa (2005b) which does so in the case of manufactures. Most of the empirical works have estimated the parameters of the gravity model by log-linearising and by applying Ordinary Least Squares (OLS) or Tobit. The effect of heteroskedasticity on the consistency of the obtained estimates has not been analysed. This paper is aimed at multiplicatively estimating the parameters of the gravity equation by using the Poisson pseudo-maximum-likelihood (PPML) estimator, and taking heteroskedasticity into account at the same time. Besides, in order to compare the results, the model will be estimated trough OLS and Tobit, and the precision of the different indicators will be assessed by a set of specification tests. Results indicate that the effects of Preferential Agreements are very sensitive to the method chosen to estimate the gravity model and the results obtained under PPML are the most reliable. Estimates associated to dummy variables which quantify the effects of the different blocks, present important differences according to the applied methodology. Consequently, conclusions on trade creation or trade diversion must be considered cautiously. This paper is divided into five sections. After the introduction, section two presents the evolution of the functional form of the gravity model and that of the estimation methods that have been applied, intending to justify the finally adopted model. Section three presents the data, while section four shows the parameters’ estimates. Finally, the last section is destined to the conclusions.