gravity equation 2003 new

8/13/2019 Gravity Equation 2003 New

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The classical and new trade theory can

uccessfully explain the reasons for

ountries to join in world trade; however

hey cannot answer the question of theize o f the trade f lows.

the gravity model, which has been used

ntensively in analyzing patterns andperformances of international trade in

ecent years, can be applied to quant i fy

he trade f low s empir ical ly.


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The gravity model has long been

riticized for lack ing in theoret ical

oundat ion. Therefore in recent yearshere has been increasing interest in

providing the theoretical support for the

ravity model.

The name comes from the analogy to

ssac Newtons law of gravity, where the

orce of attraction between two bodies

epends on the bodies masses divided

by the squared distance.


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here are huge numbers of empirical applications of gravity

odel; it is not strange to have many variations of gravity

quation. However, the gravity model shares some commoneatures :-

GRAVITY MODEL IS APPLIED TO EXPLAINBILATERAL TRADE, THE DEPENDENTVARIABLE IS ALWAYS THE TRADE VARIABLE.

THE ECONOMIC MASS OF EXPORTING AND IMPORTINGCOUNTRY ARE MEASURED BY GDP OR GDP PER CAPITA,

GNP OR GNP PER CAPITA. THE IDEA BEHIND THIS ISCOUNTRIES WITH HIGHER INCOME TEND TO TRADE

MORE AND THOSE WITH LOWER INCOME TRADE LESS.

DISTANCE IS ANOTHER VARIABLE, ALSO APROXY FOR TRANSPORT COST, WHICH IS

USUALLY MEASURED AS THE STRAIGHT LINEDISTANCE BETWEEN THE COUNTRIES

GEOGRAPHIC CENTERS.

DUMMY VARIABLES ARE ALWAYS INCLUDED INORDER TO INVESTIGATE THE QUALITATIVE

VARIABLES.


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Tinbergenfirst applied this gravity model to

nalyze international trade flows in 1962 and

many others had followed to set up a series of

conometric model of bilateral trade flows. Theeneral gravity model applied in bilateral trade

as the following form :-

Tij =(A.Yi.Yj)/ Dij


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WHAT DOES THE THEORY SAY?

The simplest theoretical proposition of the

gravity model is that bilateral trade flowsbetween two nations tends to be directly

proportional to the product of their

respective GDPs and inversely proportional

to their distance measure. Hence, higher

the GDP ratio ,higher the trade volume andvice versa.

Distance between nations and trade flows

have a negative relationship. The Gravity

Theory essentially suggests that distance

tend to create barriers leading to highercosts.

Leamer and Levinsohn(1995) mention two

early studies and then claim

These and many subsequent studies have

found a distance elasticity of about -0.6.

Overman et al.(2003) state the elasticity of

trade volumes with respect to distance is

usually estimated to be in the interval -0.9 to

-1.5.


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According to the Gravity Theory other factors that might

affect bilateral trade flows are :

Cultural Distance-differential among nations.

Administrative Differences and Bureaucratic

hurdles. Unilaterally raised barriers could beminimized through bilateral agreements.

The Border Effect : This says that national

borders impedes trade. Empirical results about

rade between regions in Canada and in the USA

are remarkable since they show that intra-

national trade is dramatically higher than

nternational trade. Such results have been found

n other parts of the globe as well. Thus country

borders seem to matter a lot to retard trade.


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The empirical evidence for the gravity

equation in international trade is strong.Both the

role of distance and economic size are

remarkably stable over time, across

different countries,

and using various econometric methods.

Research by different economists over the

last few decades have revealed that there

is some

amount of dispersion in the estimated

distance coefficient, with a weighted

mean effect of 1.07 and 90% of the

estimates lying between 0.28 and 1.55.

Despite this dispersion, the distance

coefficient has been remarkably stable,

hovering around 1 over more than a

century of data .


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TRADE WITH INDIA

b2(dist) b1(GDP) a(const)

Trade(in mil. Eu) GDP(bil.$) Distance(k.m) -0.66231 3.747794 9990.348

A 1116 88 6532.76

RAIN 1179 32.4 2960

LIPINES 1253 417 4630.43

NTINA 1329 747 15944.49

OCCO 1434 171 8472.65

BAIJA 1438 98 3685.51 Correlation b/w trade and gdp 0.7757NMAR 1460 89 1768.23

RIA 1600 274.5 7699.53 Correlatiob b/w trade and dist -0.062

ANIA 1619 74 5888

AN 1623 38.7 4403.6

N 1683 57.8 3265.52

MBIA 1801 500 15989.86

STAN 1810 515 1454.48

AMAS 1890 11 14350.49

AINE 2359 335 5244.11E 2442 319 16710.51

L 2647 40.5 1013.31

A 3025 76 5021.79

N 3357 91 2393.59

ANKA 3530 126.2 1429.38

ADA 3591 1446 11481.96

EY 3686 1125 4636.36

CO 3966 1758 15111.31

T 4271 538 4929.08

G'DESH 4329 306 1223.69

NAM 4351 320 3193.86

EL 4844 248 4539.52

IA 5242 2486 4991.25

OLA 6645 126.21 7562.9

LAND 6964 646 2385.59

IL 8987 2330 14791.86

Z'LA 9579 402 15217.17

RICA 10120 579 8264.28

AYSIA 11030 492 3087.57

RALIA 12038 961 7822.21

12443 997 3646.15

AR 13155 189 2890.47

REA 13955 1622 4693

AIT 14694 166 3310.4

N 14955 4616 5965.98

GKONG 15388 364 3637.79'SIA 15564 1212 4490.02

16006 155 3751.47


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TRADE-GDP REGRESSION LINE


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TRADE-DISTANCE REGRESSION LINE


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Size of EuropeanNations and their tradewith the US

ource-U.S Department of Commerce, European Commission


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omparing Trade with E.Unations and neighboring countrie

ource-U.S Department of Commerce,

uropean Commission


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MORE ON

THE

GRAVITY

EQUATION


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A basic flaw of the Gravity Equation isthe analogy with the Newtonian Gravity

equation ,which states that Gravity

between two bodies can be very small

,but never zero.

We know ,however ,that it is absolutely

possible that two countries might not be

engaged in any kind of mutual trade.

The existence of observations for which

the dependent variable is zero creates a

problem for use of the log-linear form of

the gravity equation .

The Achilles Heel of the Gravity Theory

is its inability to explain the effect of

distance on trade. With the increasing

advancement of technology

,transportation has become extremelyconvenient ,and the role of distance on

trade should have diminished. But

empirical data has clearly shown even

now trade has a strong negative

correlation with distance.

GRAVITY DEFYING TRADE


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The analogy between trade and the physical force of

ravity, however, clashes with the

bservation that there is no set of parameters for

which the gravity equation will hold exactly for

n arbitrary set of observations. To account for

eviations from the theory, stochasticersions of the equation are used in empirical studies.

Tij = 0Y 1i Y 2j D3ij ij(1),

ives the Gravity Equation

where ij is an error term with E(ij |Yi, Yj, Dij) =, assumed to be statistically independent of the

egressors, leading to

E(Tij |Yi, Yj, Dij) = 0Y 1i Y 2j D3ij .

There is a long tradition in the trade literature of

og-linearizing (1) and estimating the parameters

f interest by least squares using the equation

n (Tij) = ln(0) + 1 ln (Yi) + 2 ln (Yj) + 3 ln

Dij) + ln(ij)..(2)


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The validity of these procedure depends on the

ssumption that ij , and therefore ln(ij), are

tatistically independent of the regressor. This is

ecause the expected value of the logarithm of a

andom variable depends both on its mean and

n the higher order moments of the distribution.

Hence, for example, if the variance of the error

erm ijin equation (1) depends onYi, Yj, or Dijhe expected value of ln(ij)

will also depend on the regressors, violating the

ondition for consistency of OLS.


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USES OF THE GRAVITY EQUATION

To test for dispersion relat ions hip : The gravi ty

equat ion helps us establ ish that s im i lar

cou ntr ies(in GDP terms) shou ld t rade more w ith

each other rather than w ith diss im i lar cou ntr ies.

Effect o f Trade Policy : It is a large research

pro gramme to test for the effects o f trade po l icy.In g ravi ty equations one somet imes inc lude

dummy var iables for m embership o f f ree trade

org anizations. General ly, such regression s

indicate that t rade pol icy is impo rtant for

internat ional trade. Countr ies w ith low trade

barr iers between them trade more than do othercountr ies.

Coun try Borders : Empir ical research about

t rade between regions in Canada and between

region s in Canada and in the USA show that

intra-nat ional trade is dramatical ly h igher than

internat ional trade. This is so also for US-

Canadian trade wh ich is one examp le of two

high ly integrated coun tr ies. Thus country bo rders

retard trade.


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CONCLUSION

The GRAVITY EQUATION of trade has achieved

what the Ricardian Model or the H-O model could

not ,i.e. ,to quantify trade flows. Even in the 21st

century , the equation has shown immense

empirical strength . Although the theoretical basis

of the model is lacking ,with the advancement of

research and economical studies ,we can only

hope that the Gravity Equation will become a more

mainstream theoretical model in Trade Theory .


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eference

Wikipedia.comDistancefromto.net

rade.ec.europa.eu.org
http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113390.pdfhttp://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113390.pdf

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