As the research aims to employ the ‘Gravity Model’ to evaluate impacts of regional trade agreements such as AFTA on its membership’s trade flows, an empirical framework has to be constructed. Nevertheless, as far as the theoretical grounds of the
‘Gravity Model’ and its empirical specification are concerned, this part of the research
highlights a theoretical note from Oguledo and MacPhee (1994) which has the same objective: assessing the trade effects of the RTA(s).
In brief, Oguledo and MacPhee (1994) differs slightly from Anderson (1979)’s study in the area, in that the notion of price was directly addressed. This concept is also different from other traditional settings of the ‘Gravity Model’ as price terms were commonly omitted or perceived to be implicit. Thus, besides all necessary assumptions previously imposed in Anderson (1979) (Cobb-Douglas utility functions, productions of traded goods and non-traded goods and a preference function that is weakly separable with respect to the partition between traded goods and non-traded goods), the study explicitly included price terms in the function determining the share of all traded goods in the
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country’s (i and j) total expenditure63. As Фiand Фj represent the country’s (i and j) shares of all traded goods in the total expenditure, these were therefore described as:
Фi= Fi (Yi, Ni, Pi) (2.17) Фj = Fj (Yj, Nj, Pj) (2.18)
where, as previously, Yi and Yj represent the income of country i and country j, respectively. Ni and Nj denote the population size of country i and country j. In this setting, the terms Pi and Pj were imposed to capture price levels in both countries. To complicate the scenario further, trade costs which were accounted in the form of distance were incorporated in this setting. Country j’s imports from country i were thus defined as:
(2.19)
where Mij refers to the value of imports, Tij represents the distance from country i to country j64 and symbolizes the share of traded goods i in country j’s total expenditure on tradable goods. As the trade balance condition is assumed, the above equation further implies trade relationships for country i:
(2.20)
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This is perceived to represent the income effects whereby Фi and Фj are changed because of the change
in relative price.
64 Oguledo and MacPhee (1994) in fact explained that besides distance, ad-varolem tariffs might be
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The study solved for and substituted it back into Eq. (2.19); the ‘Gravity Model’ was therefore derived as:
(2.21)
where . In this application, TCij can be seen as the total trade resistance
variable of which, distance is only a part65. However, this term was elaborated further to include ad- varolem tariffs as:
(2.22)
where denotes transport costs from country i to country j andtj represents the ad-
valorem tariffs that are imposed by country j on imported goods from country i. Since
the denominator of Eq. (2.21) was treated as a constant (k), Oguledo and MacPhee (1994)substituted Eq. (2.17) and (2.18) into Eq. (2.21), the gravity equation was, as a result,specified as:
(2.23)
65 This explanation is in accordance with numerous empirical accounts in which other factors such as
communal languages, common borders as well as ad-valorem tariffs, have also been found to play a role in influencing bilateral trade flows across countries
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In their application, a set of dummy variables was, in addition, added to capture any preferential effects from trade agreements66. The above equation was rewritten as the log-linear form giving the estimating gravity equation as:
logMij = log(γ/k) + α1logYi + β1logYj + α2logNi + β2logNj + α3logPi + β3logPj + δlogTC^ij + ωlogtj + τlogdij + logUij (2.24)
where dij represents a set of trade preferential dummy variables.
As evaluating effects of trade preferential policies or regional trade agreements has been one source of issues that the ‘Gravity Model’ has exploited, forms of the empirical model as well as those following specifications similar to the set-up stated above have been relied on in a number of studies67. As far as the objective of assessing RTA(s)- effects is concerned, it can be said that Oguledo and MacPhee (1994) has not only confirmed theoretical supports for the augmented ‘Gravity Model’ generally employed
in empirical studies, but also justified one of the most common specifications of the gravity equation being used. As briefly aforementioned, more than a few studies have attempted to derive a theoretically-driven ‘Gravity Model’. The fact that different economic theories could be used to provide grounds for the ‘Gravity Model’ primarily explains why there have been various forms of the gravity equations specified in
66 Theyaimed to examine effects of preferential trade arrangements among 11 major preferences giving
countries. The gravity model is estimated on a cross-section of imports by 11 major preference giving countries from 162 countries in the year 1976.
67 In practice, the dependent variable has been specified as export, import, or total trade (export plus
import). See, for instance, Frankel (1993a), Frankel and Wei (1993, 1996), Leamer (1993), Frankel, Stein and Wei (1995,1998), Shamar and Chua (2000).
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empirical research. In summary, it is fair to say that the standard ‘Gravity Model’ has valid theoretical foundations.