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As the empirical literature review of Chapter 2 indicates, most commercial diplomacy related empirical studies focus on trade outcomes. The few that do not do so utilise self-reported outcome measures for service quality (Ruël & Zuidema, 2012; Ruël & Busschers, 2012) or firm-level sales (Abeson & Taku, 2007). The hypotheses developed in Chapter 2 follows the focus on trade outcomes. This thesis has selected the gravity model of international trade to describe the underlying relationship between trade outcomes and commercial diplomacy.

In its simplest form, the gravity model states that trade between a country-pair is directly proportional to their GDPs as well as the geographical distance between them; the larger the GDPs, the more they will trade, and the inverse is true for the distance between them (Aviat & Coeurdacier, 2007; Baier & Bergstrand, 2001; Feenstra, 2004). Analogous to Isaac Newton's theory of gravity is a multiplicative model for this relationship, describing trade flows between two countries:

(3.1) 𝐹𝑖𝑗 ∝ 𝑀𝑖∗ 𝑀𝑗

𝐷𝑖𝑗

Where M stands for the economic mass of countries i and j, Dij is the distance between

the two countries, and Fij is the trade flow between those two countries. This

relationship has performed well empirically since Tinbergen’s (1962) original work on the subject (J. E. Anderson, 1979; Baier & Bergstrand, 2001; Feenstra & Kee, 2004; Sattinger, 1978)22. When the gravity model was first used, it was based on the hypothecated relationship in equation (3.1). A formal theoretical foundation appeared later with Anderson (1979). Following from subsequent theoretical studies, the gravity

22 _{Pöyhönen independently published a similar paper in 1963 (J. E. Anderson, 2011; Broekel, Balland,} Burger, & van Oort, 2014; de Benedictis & Taglioni, 2011; Sattinger, 1978; Zwinkels & Beugelsdijk, 2010), though the origin of the gravity model is often attributed to Tinbergen.

55 model is now a micro-founded model (Baldwin & Taglioni, 2007; Bergstrand, 1985; Head & Mayer, 2013) derived as a reduced form from a general equilibrium model of international trade in final goods (Baier & Bergstrand, 2001).

The flexibility of the gravity model to explain trade flows from multiple perspectives makes it highly relevant when considering the hypotheses specified in Chapter 2. Several topics appear in the hypotheses: some revolve around trade outcomes related to total trade, the margins of trade, and product differentiation and its relation with commercial diplomacy. Others yet focus on determinants of trade in the form of the interplay between commercial diplomacy and trade barriers. Several hypotheses relate to commercial diplomacy from an office-level perspective in terms of resources, activities, network characteristics, and the interplay with trade barriers. The applicability of the gravity model to these hypotheses arises from the appearance of the elements within the hypotheses throughout the gravity model literature:

- Broadly taken, studies of overall trade, exports, and imports have driven the empirical gravity model literature since Tinbergen (1962) outlined his empirical study. Following the identification of the effects of distance and economic growth (GDP), the literature has explored a multitude of explanatory factors behind trade flows.

- Studies of the margins of trade, i.e. relating to export diversification and intensification, have taken place with a focus on whether nations trade with each other and how much (Helpman, Melitz, & Rubinstein, 2008), as well as on the product (Besedeš & Prusa, 2011; Dennis & Shepherd, 2011; Dutt, Mihov, & van Zandt, 2013) and firm levels (Berman & Héricourt, 2010; Lawless, 2010). This diverging set of levels at which the margins of trade can be assessed originates in the firm heterogeneity models developed by Chaney (2008) and M. J. Melitz (2003), and the explanation of zero trade flows developed by Helpman et al. (2008). The different margins of trade exist in the literature related to commercial diplomacy, where (Segura-Cayuela & Vilarrubia, 2008) focus on the country-level, Volpe Martincus and Carballo (2010b) and Volpe Martincus et al. (2011) on the product level, and (Creusen & Lejour, 2013) on the firm level.

- The literature on types of goods related to search cost follows from Rauch (1999). In this literature, information on product-level trade is often aggregated to the industry or country level. This data has served to inform studies on

56 relationship specificity (Nunn, 2007), ease of communication (Hutchinson, 2002, 2005; Lawless, 2010), and aspects of North-South trade (Hallak, 2006). The literature related to commercial diplomacy also adopts this country-level perspective.

- Numerous authors employ the gravity model to investigate the effect of institutional factors, such as the influence of cultural and informal institutional effects on trade (Aggarwal, Kearney, & Lucey, 2012; Chang, Kao, Kuo, & Chiu, 2012; Felbermayr & Toubal, 2010; Guo, 2004; Lewer & van den Berg, 2007), the effect of institutional distance or similarity on trade (de Groot, Linders, Rietveld, & Subramanian, 2004; Linders, Slangen, De Groot, & Beugelsdijk, 2005), and the effect of institutional quality on trade (Briggs, 2013; de Groot et al., 2004; Francois & Manchin, 2013; Linders et al., 2005). In the empirical literature directly related to commercial diplomacy, only Ciuriak and Kinjo (2006) address formal institutional quality.

- As indicated in the above points, empirical studies related to commercial diplomacy focus on country-level trade flows in relation to diplomatic representation (Rose, 2007; Yakop & van Bergeijk, 2011) and different trade outcomes. Several of these studies have focused on the office-level in relation to trade (e.g. Martin, 2003; Kang, 2011; Wilkinson & Brouthers, 2000). - The gravity model specification is well-suited to directly accommodate

network characteristics related to structure such as size. The literature includes research on the effect of the size of different types of networks on trade, such as those formed by immigrants (Bastos & Silva, 2012; Rauch & Trindade, 2002); educational ties (Murat, 2014); cultural factors (Rauch, 1999; Lewer & van den Berg, 2007); and businesses themselves (de la Mata, 2014; J. Lee, 2012).

To strengthen the rationale for using the gravity model beyond historical precedent, a closer look at the theoretical foundations is required to assess where commercial diplomacy fits. The key development in this respect is the inclusion of trade frictions in the gravity model specification. Adopting multilateral resistance terms into the gravity model, Anderson and van Wincoop (2004) transform the naïve model outlined earlier (Baldwin & Taglioni, 2007) to a general equilibrium model with CES preferences of the following form:

57 (3.2) 𝑋_𝑖𝑗 =𝑌𝑖𝑌𝑗 𝑌𝑊 ( 𝜏𝑖𝑗 𝛱𝑖𝑃𝑗) 1−𝜎

Here, i is the exporting country, j the importer, and W the world. In the model, X are exports, Y GDPs, and σ>1 is the constant elasticity of substitution between product varieties. The most important feature of this model lies in the second term on the right- hand side. The numerator features the inclusion of shipment costs in the form of τij,

usually relating to border and distance effects. The factors in the denominator denote the relative outward and inward multilateral resistances, respectively. Pj denotes the

prices faced by consumers in j and their relatively desirability against the rest of the world. Similarly, Πi are the trade costs that i faces when exporting to j relative to

exporting to other countries. This multilateral resistance term has since been adopted into firm heterogeneity models which make explicit how trade costs affect firms as well (e.g. Melitz, 2003; Chaney, 2008). It is by affecting trade frictions between two countries that commercial diplomacy is expected to be effective in its role as an intermediary. The heterogeneity of the effect of commercial diplomacy on trade is addressed next.