2011 179

Nikbakht Z., Nikbakht L. - The analysis of bilateral trade: The case of D8

Zahra Nikbakht, Leili Nikbakht
THE ANALYSIS OF BILATERAL TRADE: THE CASE
OF D8
Abstract
The main pillar of economic globalization is trade liberalization that resulted to competitive national
economies and then going to merging in global market. The communities that adapt their national
economies to new competitive conditions and have an important role in this game have earned a lot of
benefits from globalization phenomenon and economic competitiveness. One of the most important and
fundamental concern of developing countries is the effect and consequence of economic globalization.
In this paper, to investigate the bilateral trade among D8 Islamic countries group, the generalized gravity
model is used. The results on gross domestic products (GDP) of host and guest countries and geographical
distances are consistent to gravity theory. Furthermore, the variable of differences in economic structures
and also, the variable of economic openness have a positive relationship to bilateral transactions flows.
Zahra Nikbakht, Leili Nikbakht
Business Intelligence Journal - January, 2011 Vol.4 No.1
180 Business Intelligence Journal January
1. Introduction
Considering the current trend of
economy that are going to integration and
globalization, regional cooperation can play
an important role in the expanded presence
of countries in international scenes. For
developing countries that are not ready to
sudden arrival into free trade, the regional
convergence can be the most effective way
to gradual opening of national economies
and merge them into global economy.
The trade gravity model is a powerful
tool for explaining the bilateral trade fow
and volume, which is widely applied to
analyzing the inter-national bilateral trade
volumes since the 1960s and estimating
trade potentials, identifying the effects of
trade group, explaining the trade patterns
and assessing the cost of a border trade (Lin
and Wang, 2004; Liu and Jiang, 2002; Sheng
and Liao, 2004). So it better explained
some economic phenomena observed
in the reality. From the 1960s to 1970s,
many studies concentrated on the extended
model to optimize the trade gravity model
gradually.
Regarding the extended trade gravity
model, the economist mainly introduced
the new explanatory variables to modify the
basic gravity model. These new variables
are divided into two types: one is exogenous
variable that affects the trade volume, like
population, per capita GDP and so on, the
other is the dummy variable such as the
preferential trade agreement, integration
organization and so on (Shi et al., 2005).
Aitken (1973) added new dummy variables
to estimate the impact of European Economic
Community on the trade of its member states.
Frankel and Wei (1993) found that the level
of economic development, i.e. per capita
GNP, in a country is an additional signifcant
factor to determine bilateral trade.
Researchers used the resultant extended
gravity model to explore the effects of
regional groups on the trade performance.
In the late 1990s, Frankel and David (1999)
took both domestic and bilateral trade
volumes as the research objects. Although
the gravity model answers the question of
the fow direction of trade successfully in a
quantitative way, the prediction of potential
bilateral trade volumes is restricted because
of a lack of reasonable economic theoretical
foundation (Liu and Jiang, 2002). In recent
years, the theoretical foundation of gravity
model has been further consolidated
by Anderson, Helpman, Krugman,
Bergstrandand and Deardorff (Sheng and
Liao, 2004).
The D8 group consist of eight developing
Muslim countries includes Iran, Turkey,
Pakistan, Bangladesh, Malaysia, Egypt
and Nigeria. The general goals of D8 are
reinforcement and promoting the position of
developing countries in the world economy,
diversifcation and creation of new
opportunities in trade terms, increasing the
decision making role of D8 in international
levels and providing better life standards
(general welfare) for people in member
countries.
This study investigates whether there is a
bilateral trade among D8 members. Because
of differences in the economic structure of
members and also because the locations of
D8 members are geographically dispersed,
fewer studies investigate the economic
convergence of this group.
There are several studies on bilateral
trade. In the convergence and bilateral trade
feld, various models are used. Because of
the fexibility of gravity model, in this paper
we applied it to survey the bilateral trade in
D8.
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2. Model specification
Although aspersions have been cast
on the respectability of the gravity model
of trade in the past, by now its theoretical
pedigree has been proven. Earlier work
surveyed by Deardorff (1984, 503-06),
provided a partial foundation for the
approach. More formal approaches relied on
product differentiation. The assumption that
products are differentiated symmetrically
by country of origin has become associated
with Armington (1969). Anderson (1979)
adopted a linear expenditure system in
which the preferences for a countrys goods
are assumed to be homothetic and uniform
across importing countries. Bergstrand
(1985) assumed a more fexible utility
function that allowed him to fnd evidence
that imports were closer substitutes for
each than for domestic goods. He called
his equation a generalized gravity model
because it also included price terms.
The best-known theoretical rationale
for the idea that bilateral trade depends on
the product of GDPs comes from work by
Helpman (1987) and Helpman and Krugman
(1985, section 1.5).
More recently, Deardorff (1998) has
changed his mind, having discovered how
to derive the gravity model from Heckscher-
ohlin theory almost as easily as from the
theory of imperfect substitutes. His main
purpose is to show that the empirical success
of the gravity equation does not necessarily
support the imperfect-substitutes model
relative to the Heckscher-ohlin model. For
our purposes, the main point is that it seems
possible to derive the gravity model from a
variety of leading theories. The equation has
thus apparently gone from an embarrassing
poverty of theoretical foundations to an
embarrassment of riches!
To most readers who have not studied
enough trade theory to have lost sight of
the obvious, the assumption that trade
between countries depends positively on
their size and inversely on distance may
seem self-evident. Those trade theorists who
previously questioned the foundations of the
gravity model did not have an alternative
model of bilateral trade to offer. It was
just that economics has not tried very hard
to model bilateral trade. Deardorff (1998)
concludes:
While the derivation of a proportionate
relationship between trade fows and
country size is an important foundation, the
theories of Helpman (1987) and most of the
other authors cited do not include a role for
distance and thus cannot properly be called
foundations of the full gravity model. The
few exceptions include Bergstrands (1985)
version of the imperfect-substitutes theory,
which incorporated a role for shipping costs,
proxied in practice by distance. Distance
is also included in the second of the two
Heekscher-Ohlin-based models developed
by Deardorff (1998). The proportionality
between bilateral trade and the product of
incomes, as well as the inverse dependence
on distance, are also properties of our
theoretical model, introduced in chapter 7.
We assume that transportation costs raise
the price of a good in the importing country
and that distance has a positive effect on
transportation costs.
Once, one has incorporated rote for
distance in raising the cost of trade, it is
a small step to think of similar roles for
dummy variables indicating whether the
pair of countries shares a common border
or common language. Each of these links
helps reduce the cost of doing business
abroad, just as proximity does. Near the
border, consumers can cross over to shop
in the other country and frms can source
intermediate inputs in the other country,
much more readily than would be possible
if the countries did not share a common
Nikbakht Z., Nikbakht L. - The analysis of bilateral trade: The case of D8
Zahra Nikbakht, Leili Nikbakht
Business Intelligence Journal - January, 2011 Vol.4 No.1
182 Business Intelligence Journal January
border. Linguistic links and other historical
and cultural links are particularly important
at reducing what in the preceding chapter
we called the cost of unfamiliarity in
international trade what Linnemann (1966)
called psychic costs.
The variable that calls for more serious
modeling than anyone has yet done is per
capita income. These three variables-
common border, common language, and per
capita income-are discussed below, as we go
through the estimation results. We speak of
these three variables as constituting part of a
standard full gravity model, while income
and distance constitute the basic gravity
model. In recent years, there have been many
other extensions of the model, some pursued
as part of our research, some by other authors.
Empirical research has generated a number
of alternative specifcations for the gravity
model. In the context of international trade,
the basic formulation of the gravity equation
is as follows:
(1)
The gravity model applied in economics
focuses on the economic conditions and
geographical distances. According to this
model, the more strong economies of
two regions and/or the less geographical
distances between economies, the more
trade fows, migrations of labor and
information fows between these regions. In
the framework of this model, we can enter
the obstacles and persuasions (in the form
of quantitative and qualitative variable) into
model and investigate the effects of them
on bilateral trade (Harris & Matyas, 1998).
In this paper, the investigation of economic
convergence among D8 members requires
a two stage test. By introducing regional
dummy variables to estimate appropriate
trade effects for D8 into equation (1), in
the frst stage, the basic formulation of the
model (1) in the logarithmic form can be
extended as follows:
(2)
Where
X
ijt
: The export of country i into country
j in year t
GDP
it
: Gross domestic product of country
i in year t. It is expected that for home and
host countries, this variable has a positive
effect on bilateral trade.
POP
it
: The number of population of
country i in year t. is expected that for home
(host) country, this variable has a negative
(positive) effect on bilateral trade.
SIMI
ijt
: Similarity in economic structure
of country i and j in year t that are calculated
as follows:
This defnition is presented by Helpman
(1987). It is expected that this variable has a
negative effect on bilateral trade.
Open
it
: Indicates the economic openness
degree of importer countries and are
calculated as Open
it
=T
it
/GDP
it
where T
it

is foreign trade of country i in year t. It is
expected that this variable has a positive
effect on bilateral trade.
TP
ijt-1
: Indicates the extant of dynamic
fow of goods and services between
countries i and j (i.e, the trade policy). As
the trade policy variable, TP
ijt-1
express the
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trade balance between countries i and j and
are calculated as:
TP
ijt-1
=|X
ijt-1
-M
ijt-1
|/(X
ijt-1
-M
ijt-1
)
where X
ijt-1
represents the export of
country i to country j in year t-1 and
M
ijt-1
represents the imports of country i
from country j. This measure takes the
values between 0 and 1, TP
ijt-1
=0 when the
trade is quite unilateral and TP
ijt-1
=1 when
the trade is quite bilateral. It is expected
that this variable has a negative effect on
bilateral trade.
After estimation the model (1) in the
second stage the effect of variables which
are constant over time, are investigated.
Thus, the estimated intercepts from model
(2) are regressed on geographical distances
among economic centers (i.e. countries):
(3)
FE
ijt
=
o
+
2
Log(Dis
ij
)+
ijt
Where FE
ijt
is individual fxed effects
from model (2) and Dis
ij
is geographical
distances between capital of country i from
capital of country j. on the other word, Dis
ij

indicates the transportation costs between
countries i and j, indirectly.
3. Research results
3.1. Data source
We use data on the eight countries
of D8 members, Iran, Turkey, Pakistan,
Bangladesh, Malaysia, Egypt and Nigeria,
were obtained from International Financial
Statistics (IFS), and published by the
International Monetary Fund (IMF) from
1985 to 2007.
3.2. Panel unit root tests
We implement fve different types of
panel unit root tests: the Im et al. (2003)
test (IPS), and the Fisher-type ADF and
PhillipsPerron (PP) tests. Results are based
on the inclusion of an intercept and trend.
The results of panel unit root tests in level
and one order of differentiation are reported
in Table 1.
Table 1: Panel unit root test results
Variable X
ijt
GDP
it
POP
it
Series in level:
Im, Pesaran,
and Shin
-6.32 3.45 19.64
(0.00)* (0.99) (1.00)
FisherADF
385.25 96.47 173.30
(0.00)* (0.85) (0.00)*
FisherPP
536.19 89.87 634.37
(0.00)* (0.94) (0.00)*
Series in frst diferences:
Im, Pesaran,
and Shin
-24.99 -12.20 -14.64
(0.00)* (0.00)* (0.00)*
FisherADF
670.75 395.09 366.15
(0.00)* (0.00)* (0.00)*
FisherPP
1443.06 503.95 319.80
(0.00)* (0.00)* (0.00)*
* Signifcant at the 1% level
The results of all panel unit root tests
indicate that the X
ijt
is stationary in level and
frst differences. The results also show that
the GDP
it
and POP
it
both are stationary in
the frst difference, thus they are I(1).
3.3. Panel cointegration test
For the panel cointegration test, we use
the test method presented by Kao (1999).
The results of panel cointegration test are
provided in Table 2.
Nikbakht Z., Nikbakht L. - The analysis of bilateral trade: The case of D8
Zahra Nikbakht, Leili Nikbakht
Business Intelligence Journal - January, 2011 Vol.4 No.1
184 Business Intelligence Journal January
Table 2: The results of panel cointegration test
Statistics
Critical
quantity
ADF
Critical
quantity
Value -4.435 -2.890 -6.386 -3.413

DF
The results of panel cointegration test
indicate that both test statistics are lower
than the critical quantities expressing that
research variables are cointegrated, thus we
can estimate the models (2) and (3).
3.4. Model estimation
First, we run the restricted F-test and
Hausman test to determine the best structure
to estimate the model (1). The results of
selection model tests and estimated model
(1) are presented in Table (3). The results of
restricted F-test (F=365.66, P-value=0.00)
indicate that the fxed effects model is
better than the pooled estimation for model
(1). The results of Hausman test (H=23.10,
p-value=0.00) also show that the fxed
effects model is better than the random
effects model. Therefore, to estimate the
model (1), we apply the fxed effects model
approach.
Variable Coefcient T- Statistics P-value
Intercept -10.64 -4.35 0.00
Log(GDPIT
it
) 0.61 3.55 0.00
Log(GDP
jt
) 0.62 6.97 0.00
Log(POP
it
) -7.25 -5.58 0.00
Log(POP
jt
) 7.76 5.37 0.00
SIMI
ijt
-0.71 -6.31 0.00
Log(Open
it
) 1.02 6.21 0.00
Log(TP
ijt-1
) -0.00 -0.05 0.96
Restricted F-test F=365.66 0.00
Hausman test H=23.10 0.00
R
2
=77.34% Adj.R
2
=74.23% F-statistics=668.93 P-value=0.00
The estimated results of model (1)
indicates that all variables (except for
Log(TP
itj-1
)) are signifcant at the 1% level.
Consistent to theory, the GDP of home (0.61)
and host (0.62) countries have a positive
relationship to bilateral trade. The population
of home (-7.25) and host (7.76) countries
have a negative and positive relationship
to bilateral trade, respectively. Similarity
in economic structure has a negative effect
(-0.71) on bilateral trade and economic
openness degree of importer countries has
a positive effect (1.02) on bilateral trade.
Finally, the extant of dynamic fow of goods
and services between countries has no
relationship to bilateral trade.
Results also indicate that about 74% of
changes in bilateral trade are explained by
independent variable. As the F statistic of
estimated model (668.93) is signifcant at
the 1% level, the model (2) is signifcant,
too.
The estimation results of model (3)
are reported in table 4. In this model, the
dependent variable is individual fxed effects
resulted from model (2) and independent
variable is geographical distances among
D8 countries.
Variable Coefcient T- Statistics P-value
Intercept 43.70 2.09 0.04
Log(D
ij
) -5.19 -2.10 0.04
Restricted F-test F=365.66 0.00
Hausman test H=23.10 0.00
R
2
=7.56% Adj.R
2
=5.85% F-statistics=4.42 P-value=0.04
Table 3. The estimation results of gravity model (1) Table 4. The secondary estimation of gravity model
The estimation results of model (3) report
that geographical distance has a negative
and signifcant (-5.19, t=-2.10) relationship
to individual fxed effects and thus has a
negative and signifcant relationship to
bilateral trade. Results also show that about
6% of changes in individual fxed effects
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are explained by distance variable. As the
F statistic of estimated model (4.42) is
signifcant at the 5% level, the model (3) is
signifcant, too.
4. Conclusion
In this paper, we studied the bilateral
trade in D8. Similar to previous papers in
this area of research, we apply a generalized
version of gravity model to analysis the
bilateral trade in D8. In this model, we
enter the similarity in economic structure,
the economic openness degree of importer
countries and the trade policy into the basic
model and use it to survey the bilateral trade
in D8.
The results indicate that all variables
(except for the policy trade) in used model
have expected sign and are signifcant. In
summary, results indicate that the GDP of
home and host countries has a positive; the
population of home (host) country has a
negative (positive); similarity in economic
structure has a negative and the economic
openness degree of importer countries has
a positive effect on bilateral trade. Also,
the results indicate that the geographical
distances among capital of D8 members has
a negative relationship to bilateral trade.
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