COMPARATIVE ANALYSIS OF TRADE EXPLAINING FACTORS: EVIDENCE

FROM KYRGYZSTAN AND TAJIKISTAN

A THESIS
Presented to the MA Programme
of the OSCE Academy
in Partial Fulfillment of the Requirements for the Degree of
Master of Arts in Economic Governance and Development

by:
Guljahon PIRMAMADOVA

November 2016
 DECLARATION

I declare that I clearly understand the OSCE Academy Essay and Master Thesis

Writing and Anti-plagiarism Rules; and that the submitted dissertation is accepted by

the OSCE Academy in Bishkek on the understanding that it is my own effort without

falsification of any kind.

I declare that I clearly understand that plagiarism and cheating are academically

fraudulent and serious offence against OSCE Academy Rules.

I declare that I am aware about the consequences of plagiarism or/and cheating.

Name:

Signature:

Date:

ii
 ABSTRACT
The study examines changes in external trade patterns of Kyrgyzstan and
Tajikistan. In doing so, the research identifies to what degree the traditional gravity
model alongside its extended versions are able to explain bilateral trade flows of the
two post-Soviet countries. The main focus is to outline chief determinants of
international trade and to estimate trade potentials of the two countries by applying
the Poisson Pseudo Maximum Likelihood estimator. Results highlight historical ties
as the main determinants of high imports. Kyrgyzstan and Tajikistan import 92 and 89
percent less from countries with which they do not share common history. As of 2015,
top trading partners with which Kyrgyz Republic has unrealized trade potential were
China, Uzbekistan, USA, India and Germany. Tajikistan, in turn, was expected to
trade more with Uzbekistan, India, Azerbaijan, United Kingdom and Czech Republic.
No similar conclusions could be drawn on export capacity of the two countries, since
factors explaining their relatively undiversified export lie beyond the scope of the
gravity equation.

Key words: trade flows, trading partners, gravity model, trade potential.

iii
 ACKNOWLEDGEMENTS
I express my enormous gratitude to a number of people whose encouragement
and support were essential for writing the thesis. I am primarily thankful to my
supervisor dr. habil Lukasz Gryszczynski for his constant support and academic
advice during the whole period of the study.
At the same time, I feel lucky to have quite responsive professors such as
Gregory Dunn, Jayarethanam Pillay and Nurgul Ukueva at the OSCE Academy. Their
suggestions and reflections on empirical and technical parts of the study were of
particular importance.
Special thanks to professor Joao Santos Silva for his valuable comments on a
few issues encountered in the results of the estimations. His activeness in the STATA
forum was also of great help, since he provided responses to a set of very practical
questions.

iv
 TABLE OF CONTENTS

CHAPTER I: INTRODUCTION ................................................................................... 1

Introductory remarks .................................................................................................. 1
Significance of the study ........................................................................................ 3
Research question(s): .............................................................................................. 3
Limitations of the study .......................................................................................... 3
Scope for future research ........................................................................................ 4
Structure of the study .............................................................................................. 5
CHAPTER II: EVOLUTION OF TRADE PATTERNS: COMPARISON AND
CONTRAST .................................................................................................................. 6
Transforming features of external trade throughout uneasy path of independence ... 6
Kyrgyzstan in the Eurasian Economic Union: Implications for Tajikistan ............... 8
Development of trade patterns: similarities and differences .................................... 12
CHAPTER III: THEORETICAL FRAMEWORK ...................................................... 20
Theoretical Foundation ............................................................................................ 20
Linder vs Heckscher-Ohlin hypotheses ................................................................ 23
Literature review .......................................................................................................... 23
CHAPTER IV: METHODOLOGY AND DATA DESCRIPTION ............................ 28
Description of Methodology .................................................................................... 28
Description of the data ............................................................................................. 30
CHAPTER V: DISCUSSION OF RESULTS ............................................................. 34
Investigation of import flows ................................................................................... 34
Test for Linder vs Heckscher-Ohlin hypotheses .................................................. 39
Analysis of export flows .......................................................................................... 39
Trade potential of Kyrgyzstan and Tajikistan: Comparative analysis ..................... 41
CONCLUSION ............................................................................................................ 44
BIBLIOGRAPHY ........................................................................................................ 46
APPENDIX .................................................................................................................. 51

v
 LIST OF FIGURES
LIST OF FIGURES
Figure 1. Main trading partners of the Kyrgyz Republic in 2015 (in percent) .....Error!
Bookmark not defined.
Figure 2. Changes in the structure of export of the Kyrgyz Republic (in percent)...... 13
Figure 3. Changes in the structure of import of the Kyrgyz Republic (in percent) ..... 14
Figure 4. Main import and export partners of Tajikistan in 2015 (in percent) ............ 15
Figure 5. Changes in export structure of Tajikistan (in percent) ................................. 16
Figure 6. Changes in import structure of Tajikistan (in percent) ................................. 17
Figure 7. Quantity of products with comparative advantage ....................................... 17
Figure 8. Illustration of trading partners of Kyrgyzstan and Tajikistan countries
included in the analysis. ............................................... Error! Bookmark not defined.
Figure 9. Trend of home country GDP and external trade for the period 1995-2015.
...................................................................................... Error! Bookmark not defined.
Figure 10. Share of total import of the Kyrgyz Republic for the period 1995-2015 (in
million USD)................................................................................................................ 35
Figure 11. Trend of trade and GDP of Tajikistan during the period 1995-2015. ........ 37
Figure 12. Share of total import of Tajikistan for the period 1995-2015 (in million
USD). ........................................................................................................................... 38
Figure 13. Share of export of the Kyrgyz Republic. .... Error! Bookmark not defined.
Figure 14. Share of export of the Republic of Tajikistan.Error! Bookmark not
defined.
Figure 15. Untapped trade potential of the Kyrgyz Republic in 2015 (in million USD).
...................................................................................... Error! Bookmark not defined.
Figure 16. Untapped trade potential of Tajikistan in 2015 (in million
USD)……..…Error! Bookmark not defined.

vi
 LIST OF ABBREVIATIONS
CA – Central Asia
CET – Common External Tariff
CIS – Commonwealth of Independent States
CISFTA – Commonwealth of Independent States Free Trade Agreement
EAEU – Eurasian Economic Union
ECI – Economic Complexity Index
ECU – Eurasian Customs Union
EU – European Union
EurAsEC – Eurasian Economic Community
FSU – Former Soviet Union
FTA – Free Trade Agreement
GDP – Gross Domestic Product
ITC – International Trade Center
MFN – Most-Favored-Nation
NLS – Non-linear Least Squares
PCGDP – Per Capita Gross Domestic Product
PCGDPD – Difference between Per Capita Gross Domestic Product
PPML – Poisson Pseudo-Maximum Likelihood
PTA – Preferential Trade Agreement
RCA – Revealed Comparative Advantage
REER – Real Exchange Rate
SES – Single Economic Space
UN Comtrade – United Nations Commodity Trade Statistics Database
USD – United States Dollar
USSR – Union of Soviet Socialist Republics
WB – World Bank
WBDI – World Bank Development Indicators
WDI – World Development Indicators
WTO – World Trade Organization

vii
 CHAPTER I: INTRODUCTION
Introductory remarks

Tajikistan and Kyrgyzstan are two small post-Soviet countries with landlocked
geographical locations. Both of the countries are also remote from the main trading
centers with access to seaport. Their mountainous terrains necessitate finding
alternative trade routes, thereby impeding their trading opportunities even further.
There are a number of other common and country specific features (to be discussed in
more detail) which have negatively influenced trade potential of the two countries.
Soon after gaining independence, Kyrgyzstan and Tajikistan together with
some other post-Soviet states started actively engaging in various reintegration
initiatives. As soon as on 21 December 19911 the two countries signed the
Commonwealth of Independent States (CIS)2 agreement, which established some
form of cooperation among its member states. Coordination in the spheres of trade
and finance was among the main aims of this regional organization. Afterwards, the
cooperation was further advanced to economic and humanitarian spheres.
The three further stages of integration comprised Eurasian Economic
Community3 (EurAsEc) (2000-2014), Eurasian Customs Union4 (ECU) (2010-2014)
and Single Economic Space5 (SES) (2012-2014), during which common customs
territory was set and free movement of goods, labor, services and capital were
ensured. Subsequently, these latter integration stages formed legal foundation for
establishment of the Eurasian Economic Union6 (EAEU) among Russian Federation,
Kazakhstan and Belarus. Armenia became full member of the EAEU on 2 January
2015, whereas Kyrgyzstan’s accession came into force on 6 August 2015.

1
Commonwealth of Independent States, “Historical Reference”, accessed October 1, 2016
http://www.e-cis.info/page.php?id=19397

2
Other CIS members are Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan,
Moldova, Russian Federation, Tajikistan and Uzbekistan. Turkmenistan became an associated member
in 2005, while in 2009 Georgia withdrew its membership.

3
EurAsEC member states comprised Russian Federation, Kazakhstan, Kyrgyzstan, Belarus
and Tajikistan

4
ECU member states were Russian Federation, Kazakhstan and Belarus

5
SES was in force among Russian Federation, Kazakhstan and Belarus

6
EAEU is a regional economic integration in force since 1 January 2015.
 It is notable that unlike Kyrgyzstan, which membership decision followed all
regional integration initiatives except that of the ECU, Tajikistan has been more
hesitant in terms of its accession. As with the SES and ECU, Tajikistan has not
undertaken concrete steps in order to become member of the EAEU, limiting itself
with expressing its membership interest and examining possible accession impacts.
Although free trade among the CIS countries was in effect on the bilateral
basis soon after establishment of the organization, since 20 September 2012 the CIS
Free Trade Area agreement (CISFTA)7 replaced all bilateral deals with a single
multilateral agreement. Kyrgyzstan enforced the agreement on 13 December 2013.
Ratification of the CISFTA from the Tajik side, in turn, took place only on 24
December 2015, thereby positioning Tajikistan as the last member of the CIS to
access the CISFTA8.
Taking into account the abovementioned integrations and preferential trade
agreements, the study focuses on identifying chief determinants of external trade of
the two countries. Regional integrations are, therefore, analyzed solely from the
perspective of their impact on trade. For this purpose the Gravity model of
international trade is applied and projected by the Poisson Pseudo-Maximum
Likelihood (PPML). The estimator was proposed by Joao Santos Silva and Silvana
Teneyro in their paper “The Log of Gravity” in 20069. The PPML estimation
technique is widely known as an alternative to the classical log-linearized estimation
approach, which was proven invalid under certain conditions. Ability of the PPML to
incorporate zero trade flows into the analysis is another important advantage of the
estimator. Finally, applying the same methodology, the research provides an estimate
of trade potential of each country and identifies trading partners with which trade
potential remains untapped.

7
Countries which ratified the CISFTA are Armenia, Belarus, Kazakhstan, Kyrgyz Republic,
Moldova, Russia, Tajikistan and Ukraine. Note that since 2016 the CIFTA is not in effect between
Russia and Ukraine.

8
CIS web portal, “Tajikistan ratified the agreement on free trade area in the framework of the
CIS,” CA-News, December 24, 2015, accessed April 15, 2016, http://e-cis.info/news.php?id=13731.

9
J. M. C. Santos Silva and Silvana Teneyro, “The Log of Gravity,” The Review of Economics
and Statistics, November 2006, 88(4): 641-658, Accessed September 10, 2006,
http://personal.lse.ac.uk/tenreyro/jensen08k.pdf

2
Significance of the study
Empirical accomplishments of the gravity model have encouraged numerous
studies on analysis of trade flows, impacts of PTAs and estimation of trade potential,
to name a few. Kyrgyz Republic and Tajikistan, although to a lesser extent, also
became subject of the analysis. Nonetheless, approach of this study differs from the
popular tendency of applying the gravity model of international trade for analysis of
trade turnover. In this respect, contribution of current research to the existing stock of
literature consists of separate examination of trade flows of Kyrgyzstan and Tajikistan
in import and export levels. It is notable that despite certain similarities between
economies of the two neighboring states, analogous comparative analyses have not
been conducted. Yet, under constantly changing realities and deepening regional
integration, examination of trade patterns of the two countries obtains distinct
necessity. Estimation of trade potential, in turn, enables distinguishing scope for
expanding trade links within the framework regional integration for Kyrgyzstan or in
the bilateral level in case of Tajikistan. Consequently, results of the research could
serve as a rationale for extracting effective policy implications for trade.

Research question(s):
In order to achieve its targeted objective, the research would provide answers
to the following questions: How has external trade patterns of Kyrgyzstan and
Tajikistan changed since independence? What has been the driving force behind these
transformations? Which factors influence international trade flows of the two post-
Soviet states in accordance with the gravity model of international trade? With which
trading partners trade potential of Kyrgyzstan and Tajikistan remains unrealized?

Limitations of the study

In the process of conducting the research several limitations were identified.
The first issue is concerning preciseness of trade indicators, which are generally
presented in rounded form in official statistical publications. On one hand, expressing
trade in million USD looks more presentable and easy to understand. On the other
hand, such technique poses significant limitation on preciseness of the final estimation
for this study. This issue is especially relevant for analysis of bilateral trade flows of
Tajikistan. The country does not provide report of registered trade to international
trade statistics database. As a consequence, unlike in case of Kyrgyzstan, more

3
precise value of Tajikistan’s trade is unavailable in alternative sources of trade
statistics.
Secondly, preciseness of the available statistics relies on the assumption that
registered value of trade flows reflects actual trade that has taken place in both
countries. In this respect, there are certain doubts concerning reliability of the
available data on trade flows. For instance, in the annual economic report of Swiss
cooperation office in Tajikistan for 2015 it is noted that the gap between the two
countries’ customs statistics on export of gold from Tajikistan to Switzerland amounts
to USD 40 million. More specifically, Swiss Customs registered 40 million USD less
import of gold than declared by the Tajik statistics10. Such discrepancies cast doubt on
the degree of preciseness of the available data, which, in turn, result in inaccurate
estimations of the gravity model of trade.
Last but not least, more precise estimation of factors which potentially explain
bilateral trade flows was limited to the availability of existed statistics. For example,
absence of statistics on cost to export necessitated excluding missing annual data from
the analysis. Missing observations, in turn, adversely affect degree of certainty of the
final estimation.
In this respect, since the abovementioned limitations should be perceived as
given, outcomes of the study are the best one could get given the existed information.
It should be noted, however, that improvements of current statistical recording of
external trade would serve as an asset for future relating researches.

Scope for future research

Since the gravity model turned out to be incapable to explain export flows of
the Kyrgyz Republic and Republic of Tajikistan, further investigations are required in
this sphere. This might entail introduction of instrumental variables to control for
certain endogenous factors which influence export flows of the two countries.
Eventually, based on estimations it would be possible to determine optimal export
potential of the two countries.

10
Swiss Cooperation Office Tajikistan, “Annual Economic Report (2015), Tajikistan“, p 6,
accessed October 10, 2016, http://www.s-ge.com/sites/default/files/WB_1605_E_Wirtschaftsbericht-
Tadschikistan.pdf

4
Structure of the study
The research launches with providing comparative analysis of trade patterns
of Kyrgyzstan and Tajikistan. In doing so, the study highlights transforming features
of trade structures of the two countries since independence. Next section reviews
theoretical framework of the gravity model, which is applied for examination of trade
explaining factors. Analysis of the literature review is subject of the third chapter.
Further chapter is dedicated to description of methodology of the study. Detailed
discussion of results is provided in chapter five. Finally, the conclusion section
summarizes the whole sections by highlighting the main issues of the study.

5
CHAPTER II: EVOLUTION OF TRADE PATTERNS: COMPARISON
AND CONTRAST
Transforming features of external trade throughout uneasy path of
independence

New realities following the dissolution of the Soviet Union necessitated rapid
switch from the long lasting centrally planned economy to the market economy. Such
abrupt need for economic reforms posed serious challenges on the economy of the
Kyrgyz Republic and Republic of Tajikistan, which primary role during the Soviet
time was limited to production of raw materials (such as gold, cotton, aluminum,
minerals, mercury, lead, zinc and etc)11. Having lost direct access to the huge once
common Soviet market, dependence on external trade (i.e. trade with other countries,
including post-Soviet states) became inevitable. Intensified dependency on import
was also determined by increase in price of importing goods, primarily energy
products, from the post-Soviet countries.
Shortly after stabilizing its regulatory environment and conducting land
reforms, Kyrgyzstan became the first among its other CIS counterparts to join the
WTO in December 1998. In this respect, the country’s accession period of two years
has become the shortest in the history of the trade organization12. In contrast, it took
Tajikistan eleven years to become full member of the WTO in 2013. As a result of
Kyrgyzstan’s WTO commitment, average import tariffs levied on goods coming from
other WTO members to its marked decreased by more than five percent13. The
country’s pre-accession tariffs were zero for the CIS and least developed countries, 5
percent for developing countries and 10 percent for the rest of the world on all
importing goods14.
Trade liberalization and enforcement of the Most-Favored-Nation15 treatment
eventually led to increase in total trade turnover of the country. Starting from 2001

Glenn E. Curtis, “Kyrgyzstan: A Country Study,” GPO for the Library of Congress,
11

Washington, 1996., accessed October 15, 2016, http://countrystudies.us/kyrgyzstan/19.htm

12
Madina Nurakisheva., “Kyrgyzstan in the WTO: Comments and Consequences,” Deloitte
Consulting, USAID Macroeconomic Project, August 2014, p. 6., accessed October 5, 2016,
http://macro-project.net/cms/uploads/usaid_mep_brochures_kyrgyzstan_in_wto_eng.pdf

13
Ibid, p 21

14
Ibid, p 19

15
MFN is a principle which provisions equal treatment of importing goods within the WTO

6
and during the next five consecutive years, an increase in total external trade turnover
of the Kyrgyz Republic constituted USD 1568, 8 million, totaling to USD 2512, 3
million in 2006. In addition, WTO membership offered the country an opportunity of
easily expanding its external market. For example, solely in one year (2005 - 2006)
the country managed to establish new bilateral trade links with 15 more WTO
members, thereby increasing the number of its trade partners to 120 countries16.
Number of Kyrgyzstan’s trade partners was further increased to 147 in 2012, while
the level of trade turnover became 2, 6 times its 2006 level 17. Instability of trade
indicators was only observable during the global financial crisis of 2009-2010, when
import declined by 28, 3 percent and export shrunk by 36, 7 percent18.
At the same time, trade liberalization reforms created favorable conditions for
re-exporting Chinese goods to Russia and Central Asia countries. Engagement in this
activity served as partial solution to the unemployment issue in the country until its
integration to the EAEU.
For Tajikistan the post-Soviet period was even more troublesome.
Independence was accompanied with the destructive 5 year civil war, during which
economic growth of the country exhibited an annual decrease of 17, 2 percent on
average, costing Tajikistan over 65 percent of its GDP19. In this regard, initial phase
of reforms in the county were rather focused on political stability and restoration of
vastly damaged economic infrastructure. Nonetheless, even after the post-war catch
up, trade indicators of the country were primarily shaped by external factors, such as
change in world price of its main export commodities, world economic crisis and flow
of remittances from Russian Federation. Such dependency on external factors resulted
in 3, 9 percent decrease of the GDP growth of the country in the economic crisis of

16
Nurakisheva, M., “Kyrgyzstan in the WTO: Comments and Consequences,” Deloitte
Consulting, USAID Macroeconomic Project, August 2014, p 22, accessed October 11, 2016,
http://macro-project.net/cms/uploads/usaid_mep_brochures_kyrgyzstan_in_wto_eng.pdf

17
Trade Policy Review Report by Kyrgyz Republic, World Trade Organization, 1 October
2013, p 6, accessed October 1, 2016, https://www.wto.org/english/tratop_e/tpr_e/g288_e.pdf

18
Ibid, p 6

19
Asian Development Bank, “Tajikistan: Promoting Export Diversification and Growth
Country Diagnostic Study,” p 1, accessed September 5, 2016,
https://www.adb.org/sites/default/files/publication/189730/taj-export-diversification-growth.pdf

7
2009. During this period export of aluminum declined by 46 percent, while cotton
export shrunk by 26percent20.
Even so, due to on-time budget support and continued economic growth in
Russia, it did not take Tajikistan long to overcome the negative impact of the 2009
crisis. The period of stable growth of trade continued 5 years. On December 2013 the
country became full-member of the WTO, which further improved the trade
environment for this country. Note that although Tajikistan is not a member of the
EAEU, it used to have free trade agreement at the bilateral level with all the EAEU
member states as part of the EurAsEC integration since 200321 until ratification of the
CISFTA. In process of its accession to the trade organization Tajikistan had to bring
modifications to more than 100 laws22 in order to bring them in accordance with the
WTO requirements.
Soon afterwards, however, decrease in prices of chief export commodities of
the country was accompanied by worsening economic conditions in Russia. Already
in 2015 reduction in export earnings of the country amounted to nine percent, while
trade turnover decrease made up eighteen percent. Devaluation of Tajik somoni
constituted 31.7 percent, which, in turn, resulted in more expensive imports.
Overall, similar to the Kyrgyz Republic, Tajikistan has followed an open trade
policy since independence. The country’s average trade turnover has increased to
more than three times compared to its level in 1991. By 2009 the number of trading
partner of the country increased to 101. Yet, even during the period of high economic
growth in the two countries since independence, their levels of GDP per capita have
been lower than prior dissolution of the Soviet Union.

Kyrgyzstan in the Eurasian Economic Union: Implications for Tajikistan

Accession of the Kyrgyz Republic to the Eurasian Economic Union (EAEU),

which other members comprise Russia, Kazakhstan, Belarus and Armenia, followed
in August 2015. As a fourth stage of economic integration, the EAEU establishes free

20
Ibid, p 24

21
KAZNEX Invest, “Republic of Tajikistan, Country Report”, p 11
http://www.kaznexinvest.kz/napr/analytics/export/cr/tajikistan_2013.pdf

22
Wep page of Tajikistan in the WTO, accessed October 15, 2016, http://www.wto.tj/en/tj-
wto/accession/process-membership/

8
movement of goods, services, people and capital within its territory. As a result of the
membership, the country gained access to the market of 174, 2 million people with a
GDP of 433, 5 trillion as of 2015. Accession decision was, nonetheless, made at cost
of neglecting trade pattern of the country, thereby enhancing probability of trade
diversion and subsequent destructive impact on economy. Negative impact on
Kyrgyzstan’s trade with non-EAEU countries comprises an increase in import duties
of the country due to higher average common external tariffs (CET) of the EAEU.
This is especially relevant to the past intensive re-export of Chinese goods, which role
is now shifted to Tajikistan. Yet, the re-export business was bread-and-butter of more
than twenty percent of the Kyrgyz working population.
It is also notable that despite the country’s accession to the EAEU, bilateral
trade of the Kyrgyz Republic fell with respect to almost all members of the integration
in 2015. The only exception is Armenia with which trade, nonetheless, remains
insignificant.
Given such influence, the EAEU membership also provides a number of
benefits for the country. Apart from facilitating access to labor market, the
membership provisions increase in customs revenue and free access to the market of
the Union. Eventually, elimination of internal customs duties and control obliges
member states to avoid short-term border closure incidents (which proved to cost
Kyrgyzstan over USD 365 – 405 million in 201023). At the same time, unification of
technical standards and documentation shall lead to substantial trade facilitation not
only within the territory of the EAEU but also with respect to non-EAEU members.
Introduction of electronic documentation further contributes to trade
facilitation among the member states. For instance, from 27 June of current year
common form of electronic passport for transportation has been introduced 24. Its
enforcement indicates elimination of the initial time-consuming paperwork, thereby
creating appropriate conditions for the member states to freely move goods across
borders.

23
Beshimov, A., Shinn, A., Usuballiev A., “Economic Consequences of the Customs Union
for the Kyrgyz Republic,” 2011, p 14, accessed October 5, 2016,
http://pdf.usaid.gov/pdf_docs/pnaec882.pdf

24
Eurasian Economic Commission, “EAEU Countries Introduce Common Forms of Electronic
Passports of Machines,” accessed October 20, 2016,
http://www.eurasiancommission.org/ru/nae/news/Pages/27-06-2016.aspx

9
 Notwithstanding, elimination of non-tariff barriers within the organization is a
gradual process requiring significant will of the member states to strengthen quality of
institutions and physical infrastructure. Results of the 2015 World Bank’s Doing
Business Report indicate that only six countries out of 189 possess higher costs of
trade across border than Kyrgyzstan25. In this respect, given the existing poor trade
facilitation environment of the country, compliance with the EAEU uniform standard
requirements is a burdensome procedure.
Note that despite its WTO commitments, the country had to double its external
tariffs (from the initial average of 5, 1 percent to 10, 4 percent of EAEU) with respect
to non-EAEU members due to its accession to the EAEU. The need to this increase is
a direct result of the size of the economies which form the integration. Russia, which
is the biggest one, sets in practice the average tariffs for other members of the EAEU.
Smaller players that want to join the Union can only accept the higher tariff. Yet, such
increase in customs duties not only makes the country’s import more expensive but
also decreases competitiveness of its key export products (such as garment and
textiles)26.
Even so, WTO commitments of Russia (which accession to the organization
took place on 22 August 2012) envisage decline of the average EAEU tariff rates to 7,
8 percent already in 2017. It is notable that this assumption did not hold true for the
already one year old WTO commitments of Kazakhstan, which lowered the country’s
average tariffs to 6.1 percent. Instead of the required adjustments in the EAEU tariffs,
which appear to be the core idea of the CET, Kazakhstan has to compensate for the
underpaid tariffs in case of re-export of goods imported from third countries to other
EAEU members27. In this regard, CET exemption list of approximately 3000 goods28
ensure membership of Kazakhstan both in the EAEU and WTO.

World Bank Group, “Doing Business in Kyrgyzstan: Going Beyond Efficiency,” A World
25

Bank Group Flagship Report, p 67, accessed September 28, 2016, http://bit.ly/2gjX7Hg

26
Claire Gicquel et al., Kyrgyz Republic: Selected Issues, IMF country Report No16/56,
Kyrgyzstan, November 19, 2016, p 43, accessed November 25, 2016,
https://www.imf.org/external/pubs/ft/scr/2016/cr1656.pdf

27
Michael Ahern et al., “Special regulations on import of goods to Kazakhstan following
accession to WTO,” Edition № 15-2016, accessed October 5, 2016,
https://www.pwc.kz/en/PwCpercent20News/tax-alerts/special-alert-15-eng.pdf

28
Claire Gicquel et al., Kyrgyz Republic: Selected Issues, IMF country Report No16/56,
Kyrgyzstan, November 19, 2016, p 44, accessed November 25, 2016,
https://www.imf.org/external/pubs/ft/scr/2016/cr1656.pdf

10
 For Tajikistan, which has not yet officially declared its accession intentions,
experience of the Kyrgyz Republic serves as a good benchmark for analysis. Note that
although Tajikistan is not a member of the EAEU, the country used to have free trade
agreement at the bilateral level with all the EAEU member states as part of the
EurAsEC integration since 200329 until ratification of the CISFTA. It is true that the
EAEU accession provisions controversial impact on trade of the Kyrgyz Republic. As
it was already discussed, the short-term impact of the accession has not been positive.
Trade with the EAEU countries fell, while higher common external tariffs with
respect to third countries made imports more expensive for the local population.
On the other hand, distinctness of the EAEU is in that the integration
provisions creation of single energy, transport and pharmaceutical market30. In this
respect, membership in the EAEU would be beneficial for the country given that
Tajikistan imports main share of its petroleum products from Russia and Kazakhstan.
Share of petroleum products in the total import structure of the country, in turn,
reaches 15 percent. It is notable that prices for gasoline are highest in Tajikistan than
in any other CIS country31.
In terms of import duties with respect to third countries the impact of
perspective EAEU accession is even negative. The issue is that since Tajikistan
ratified the CISFTA, free trade agreement among the EAEU member states would
continue being in force even without its membership in the EAEU. More importantly,
the CISFTA does not require rising its tariffs with respect to third countries.
In sum, Kyrgyzstan’s experience suggests that positive impact is provisioned
with respect to non-tariff barriers among the EAEU member states, which comprise,
among others, elimination of internal borders and stricter control of illegal trade
within the EAEU. The latter aspect is of particular importance to the country, given
the substantial volume of illegal drug trafficking route passing through Tajikistan32.

29
KAZNEX Invest, Republic of Tajikistan: Country Report, p 11
http://www.kaznexinvest.kz/napr/analytics/export/cr/tajikistan_2013.pdf

30
Library of Eurasian Integration, Eurasian Economic Integration: Facts and Figures,
Eurasian Economic Commission, 2016, accessed October 5, 2016, goo.gl/rIw9TB

31
Global Petrol Prices, “Tajikistan gasoline prices, liter,” accessed November 22, 2016,
”http://www.globalpetrolprices.com/Tajikistan/gasoline_prices/

32
US Department of State, “2015 International Narcotics Control Strategy Report (INCSR) for
Tajikistan” Bureau of International Narcotics and Law Enforcement Affairs, accessed September 29,
2016, http://www.state.gov/j/inl/rls/nrcrpt/2015/vol1/239017.htm

11
At the same time, considering Kyrgyzstan’s integration challenges, short term
negative impact with respect to third countries should be taken into account.

Development of trade patterns: similarities and differences

Prior proceeding to comparative analysis of the features of external trade

flows of the Kyrgyz Republic and Republic of Tajikistan, it is reasonable to
distinguish how the trade patterns of the two countries transformed since
independence. It might as well be the case that the two post-Soviet states possess
similar level of economic development and have convergence in the flow of their
trade structure. In this respect, brief description of chief economic indicators of the
two countries would be followed by discussion of transforming qualities of their
trading structure.
As of 2014, export economy of the Kyrgyz republic scales 148 th largest in
the world with the Economic Complexity Index 33 (ECI) ranking34 of 104th. Having
GDP per capita of USD 1,103, the country has a negative trade balance of USD
2,393 billion35 (with export amounting to USD 1,676 billion and import value of
USD 4, 07 billion). Illustration of the main trading partners of the country is
provided in figure 1.

Figure 1. Main trading partners of the Kyrgyz Republic in 2015 (in percent)

Share of export partners Share of import partners

34 31
22 25
17
9 8 6 5 4 3 12
4 2 8 2 2
1 1 1

Source: ITC database, author’s calculations.

33
The ECI indicates diversity of a country's export and its sophistication.

Observation of Economic Complexity, “Economic Complexity Rankings (2014),” accessed

34

November 22, 2016, http://atlas.media.mit.edu/en/rankings/country/2014/

35
National Statistical Committee, “Kyrgyzstan in numbers,” Bishkek, July, 2016, p 248,
accessed November 22, 2016, http://www.stat.kg/media/publicationarchive/b40aaf45-f887-467a-8b7d-
ca3943392999.pdf

12
 As it can be inferred from the figure 1, Switzerland is the main export
partner of the Kyrgyz Republic. More than 95 percent of export to this country
consists of gold. Export to Kazakhstan is rather diversified, comprising textiles (25
percent), chemical and vegetable products (14 percent each), mineral products (11
percent), animal products (6,8 percent), stone and glass and etc. Russia’s import
from Kyrgyzstan consists of textiles (29 percent), metals (17 percent), foodstuffs
(16 percent), machines (14 percent), transportations (8,2 percent) among others.
Kyrgyzstan’s structure of import from Russia, in turn, comprises mineral
products (58 percent), metals (8, 2 percent), foodstuffs (8 percent), chemical
products (6, 3percent), wood products (5, 3 percent), machines and etc. Chief export
commodities of China to the Kyrgyz Republic are textiles (60 percent), footwear
and headwear (11 percent), machines (8, 6 percent), metals (4, 1 percent), plastics
and rubbers (2, 7percent) among others. Import of the country from Kazakhstan
consists of mineral products (19 percent), foodstuffs and vegetable products (each
18 percent), chemical products (13 percent), metals (9, 3percent), transportation (5,
75), precious metals (3, 5 percent) and etc.
It is notable that compared to nowadays commodity structure of trade of the
Kyrgyz Republic has been more diversified in the early nineties. Figure 2 illustrates
modifications in the export structure of the country since 1995.

Figure 2 Changes in the structure of export of the Kyrgyz Republic (in

percent)
Gold
2015
Electricity
Road vehicle
2010
Vegetables

2005 Fruits and nuts

Petroleum oils
2000 Women's clothing
Non-ferrous metals
1995 Radio-actives and materials
Other
0% 20% 40% 60% 80% 100%

Source: calculations are based on UN Comtrade.

It can be inferred from the figure 2 that electricity had a major share in the
export structure of Kyrgyzstan during initial years of independence. Nontheless, since

13
arrival of the XXIst century export of gold constituted more singnificant share from
the whole import, while importance of electricity as as the main export commodity
gradually diminished.
It can be also concluded that compared to initial years of idependence,
contemprary structure of export of Kyrgyzstan can be separated into different
commodity types with relative ease. In other words, although total export of the
coutnry in recent years has been four times more compared to its 1995 level, its
structure has also become equally less diversified.
With somewhat lesser volatility in share of commodity, the structure of import
of the coutnry is illustrated in the figure 3. Significance of petrolium oil for the
country is evident from its relatively stable share in the whole flow of import. Import
of motor vehicles has also gained momentum since 2010. Overall, total import of the
coutnry in in recent years is more than nine times of its 1995 level, which indicates
significant increase in dependecy of the coutnry on import.

Figure 3 Changes in the structure of import of the Kyrgyz Republic (in

percent)
Petroleum oils
2015
Motor vehic.
2010 Medicaments
Chocolate
2005 Civ. engineering plant & equipment
Wood porducts
2000 Footwear
Telecommunication equipment
1995
Wheat unmilled
0% 20% 40% 60% 80% 100% Other

Source: calculations are based on UN Comtrade dataset.

Economic indicators of Tajikistan are even less competitive. Compared to its

neighbor, the country’s export economy is the 159th largest in the world, while its
economic complexity index ranks to 117th. With negative trade balance of USD
2.544 billion36 (total export reaching USD 891 million and import amounting to
USD 3,435 billion), Tajikistan’s GDP per capita fell to USD 925, 9 in 2015. Figure

36
State Statistical Agency under President of the Republic of Tajikistan, “Socio-economic
conditions of the Republic of Tajikistan for the period January-Decemberб” January 12, 2016,
accessed October 10, 2016,
http://www.stat.tj/ru/img/3c8b737e693be8769270f0f588a0a0e5_1455852583.pdf

14
4 provides visual illustration of the chief trading partners of the country for the
period 2015.
Figure 4 Main import and export partners of Tajikistan in 2015 (in percent)

Share of export partners Share of import partners

29 31
23 22
16 16
7 6 4 4 3 14
6 3 3 2
3 1 5 2

Source: Agency of Statistics under the President of the Republic of Tajikistan,

author’s calculations
Unlike in case of Kyrgyzstan, Switzerland occupies the second place in the
hierarchy of the chief trading partners of Tajikistan with gold being the principal
commodity of export. The main aim of exporting precious metals in substantial
quantity is associated with intentions of National Bank of Tajikistan to get its non-
monetary gold converted into certified monetary gold at the international level 37.
Commodity structure of Tajikistan’s export 38 to Turkey, in turn, consists of
raw aluminum (81 percent), raw cotton (11 percent), as well as non-retail pure
cotton yarn (4, 8 percent). Kazakhstan’s import from the country also comprises few
commodities such as mineral and vegetable products (74 percent and 25 percent
respectively).
In contrast, import from Russia consists of mineral products (44 percent),
wood products (14 percent), metals (11 percent), foodstuffs (8, 9 percent), chemical
products (4, 7 percent) and etc. Commodity import from China among other
comprises textiles (38 percent), machines (14 percent), footwear and headwear (11
percent), metals (11 percent), transportation (7, 3 percent), stone and glass (5, 5
percent). Import from Kazakhstan consists of vegetable products (50 percent),
mineral products (28 percent), foodstuffs (7, 8 percent), metals (4, 6 percent),

37
Swiss Cooperation Office Tajikistan, “Annual Economic Report (2015), Tajikistan”, p 1,
accessed October 10, 2016, http://www.s-ge.com/sites/default/files/WB_1605_E_Wirtschaftsbericht-
Tadschikistan.pdf

38
Observation of Economic Complexity, “Tajikistan,” accessed October 2, 2016,
http://atlas.media.mit.edu/en/profile/country/tjk/#Imports

15
chemical products (3, 7 percent) and etc. It is notable that despite the country’s
substantial negative net trade, considerable domination of export over import was
observed with Turkey (USD 122, 9 million), Switzerland (USD 100, 8 million) and
Afghanistan (USD 1, 7 million).
At this point it is reasonable to analyze how has the trade structure of the
country changed since independence. In this respect, illustration of transformations
in the commodity composition of export of Tajikistan is provided in figure 5.

Figure 5. Changes in export structure of Tajikistan (in percent)

2015
Aluminium
Cotton
2010
Fruits and nuts

2005 Vegetables
Textile yarn
2000 Electric current
Cotton fabrics, woven
1995
Other

0% 20% 40% 60% 80% 100%

Source: calculations are based on UN Comtrade

As it can be inferred from the figure 5, export of aluminum and cotton has
constituted major part of the country’s export. While in 2000 main destination
countries for export of aluminum were Russia and EU, nowadays this commodity is
mostly exported to China and Turkey. Export of cotton, in turn, was reoriented from
Switzerland, Slovakia and Latvia to Turkey, Pakistan and Iran. Exception includes
Russia which still continues remaining one of the main importers of this commodity.
Likewise, it can be concluded that relatively little variations are observed in
the structure of export of the country over time. Despite the existing substantial
potential of electricity export, share of this commodity in the total export of the
country remains mostly insignificant.
Illustration of modifications in the more diversified commodity structure of
the country’s import is provided in figure 6. While share of petroleum products in the
total structure of import has been increasing, import share of aluminum ores and
wheat products exhibited more volatility. Share of electricity import, in turn, was
most considerable in 2005.

16
 Figure 6. Changes in import structure of Tajikistan (in percent)

Petroleum products
2015
Aluminium ores & metals
2010 Metallic salts

2005 Clothing & footwear

Wheat and flour products
2000
Electricity
1995 Road vehicles

0% 20% 40% 60% 80% 100% Other

Source: calculations are based on UN Comtrade

In addition, compared to Tajikistan, Kyrgyz Republic has greater number of
export products with RCA39 (please see figure 7). Such ratio indicates higher
competitiveness of the country’s export. In case of the Kyrgyz Republic, products
with highest RCA are textile and clothing, as well as mineral and animal products40.
For Tajikistan the list comprises mostly food products and aluminum41.
Figure 7. Quantity of products with comparative advantage in Kyrgyzstan and
Tajikistan

Tajikistan Kyrgyzstan

150 91 116
70 99
100 85
48 56 55
50 60
47
0
1995 2000
2005
2010
2014

Source: Extracted from the ADB Report (2016)42.

39
According to Balassa (1965), revealed comparative advantage (RCA) is an indicator of
intensity of export of certain commodity intensity by a country compared to the rest of the world.

40
World Bank, Revealed Comparative Advantage (Kyrgyzstan), accessed October 1, 2016,
http://www.worldbank.org/en/news/video/2014/09/30/revealed-comparative-advantage-data

41
Coulibaly, S., “Shifting Comparative Advantages: Implications for Growth Strategy,” Policy
Research Working Paper; No. 6125. World Bank, Washington, DC, p 8, accessed October 1, 2016,
https://openknowledge.worldbank.org/handle/10986/11941

42
Asian Development Bank, “Tajikistan: Promoting Export Diversification and Growth
Country Diagnostic Study,” Philippines, 2016, p 14, accessed September 5, 2016,
https://www.adb.org/sites/default/files/publication/189730/taj-export-diversification-growth.pdf

17
 Figure 7 provides visual illustration of changes in the number of products with
indicator of comparative advantage greater than zero. As it can be inferred from the
figure, from 1995 till 2005 there is a significant increase in the number of export
commodities of the Kyrgyz Republic with revealed comparative advantage. Yet,
since 2005 number of such products has decreased from initial 116 to 85. In
contrast, export competitiveness of Tajikistan hardly exhibited any considerable
progress. Over 20 years number of products with RCA averaged around 53
products.
Having examined main economic indicators and changes in trade patterns of
the Kyrgyz Republic and Republic of Tajikistan, several conclusions can be drawn.
To begin with, commodity composition of export structure of Kyrgyzstan was more
diversified in the early nineties with share of electricity, non-ferrous metals, fruits
and nuts combined with vegetable products having the largest share. No similar
volatilities in the share of commodity composition of trade were observable in case
of Tajikistan. Share of aluminum, cotton and, to lesser extent, fruits and nuts have
largely explained export flow of the country with relatively stable share.
It is also notable that despite having tremendous potential for electricity
export, share of electric current in the export structure of both countries remains
limited and unstable. With initial share of 18 percent in the total export flow of the
Kyrgyz Republic in 2000, export of electric current has diminished to 2 percent in
2015, constituting almost one third of its exported level in 2000. In case of
Tajikistan decline in export of electricity during the same 15 years compose more
than 6 times. To put it differently, in Tajikistan export of electricity in its direct
form has been gradually outset by indirect form through production and export of
aluminum.
Concerning the structure of import, share of petroleum products dominate in
both countries. In the Kyrgyz Republic import of petroleum products constituted 16
percent in 2015, which was 7 percent less than the year earlier. With somewhat
slighter average share but increasing tendency, for Tajikistan import of petroleum
products in 2015 reached 15 percent of the total import. In addition, import of
aluminum ores and metals also remain relatively stable and significant for this
country.
Overall, trade and economic indicators of the Kyrgyz Republic has been
more favorable compared to its neighbor, although the degree of divergence is not

18
significant. Export of natural resources still constitutes major share of export of the
two countries with weakening index of competitiveness.

19
 CHAPTER III: THEORETICAL FRAMEWORK
Theoretical Foundation

The idea of gravity model originates from the Newton’s law of universal
gravitation, which states that attraction between two particles in the universe is
determined by a force directly proportional to their masses and inversely proportional
to distance between them. Accordingly, when applied to international trade, the
gravity model takes the following form:
𝐺𝐷𝑃𝑘 ∗ 𝐺𝐷𝑃𝑗
𝑇𝑟𝑎𝑑𝑒𝑘𝑗 = 𝛼
𝐷𝑖𝑠𝑡𝑎𝑛𝑐𝑒𝑘𝑗
where alpha represents gravitational constant, GDP traditionally serves as an
indicator of mass, while distance between two countries represents transportation
costs. These right hand side variables then in combination determine the volume of
trade between country k and j.
In its linear form the gravity model is expressed as follows:
ln(𝑇𝑟𝑎𝑑𝑒𝑘𝑗 ) = (𝛽0 ) + 𝛽1 𝑙𝑛(𝐺𝐷𝑃𝑘 ∗ 𝐺𝐷𝑃𝑗 ) + 𝛽2 𝑙𝑛(𝐷𝑖𝑠𝑡𝑎𝑛𝑐𝑒𝑘𝑗 ) + 𝑙𝑛 (𝑢𝑘𝑗 ) (1)
Despite tracing its origins from as early as in 1687, the gravity model in its
classical form was first applied in international trade by Tinbergen (1962)43 and
Poyhonen (1963)44. Initially Tinbergen’s choice of explanatory variables in his study
on international trade flows was intuitive and did not rely on any theoretical
predictions. His assumptions attributed GDP of home country to the volume of export
the country can provide and quantity of goods to be sold in its market. The volume of
trade, in its turn, was determined by transportation costs, which were supposed to be
directly proportional to distance between trading partners. The author likewise
included dummy variables (which take value of either one or zero, indicating presence
or absence of the qualitative variable in observations) to control for preferential trade
agreements and existence of common border between trading countries.
Once the results of the empirical assessment with respect to 42 trading
partners demonstrated significant coefficients of the main variables with presence of

43
Jan Tinbergen. “An Analysis of Trade flows” in J. Tinbergen (ed.), Shaping the World
Economy. Twentieth Century Fund, New York, 1962, accessed September 2, 2016,
http://repub.eur.nl/pub/16826

44
Pentti Poyhonen. “A Tentative Model for the Volume of Trade between Countries.”
Weltwirtschaftliches Archiv, 90, 93-100, 1963, accessed August 5, 2016,
http://www.jstor.org/stable/40436776

20
expected signs, the gravity model becomes widely popular among other researchers.
Soon afterwards, Linnemann (1966)45 offered classical usage of the model by
integrating supplemental variable to indicate commodity composition of trade.
Further improvements to the model were brought by Leamer and Stern
(1970)46, who highlighted the importance of transportation costs, without which it
would be impossible to determine bilateral trade flows. In addition, Leamer (1974)47
included two-digit Standard International Trade Classifications for commodities with
aggregated measures of relative factor endowments serving as independent variables
to detect the effect of income on population.
Nevertheless, despite the evident empirical accomplishments of the gravity
model, its theoretical consistency has been debated. In this respect, significant efforts
were made to detect its links with trade theories. The first attempt of finding a solid
theoretical justification to the gravity model was made by Anderson (1979)48. He
applied utility functions (i.e. Constant Elasticity of Substitution and Cobb-Douglas)
with an aim of developing the gravity model by utilizing properties of linear
expenditure systems. These properties assume that importing countries have
homothetic and uniform preferences for importing goods from a certain country. His
model emphasizes product differentiation of goods by countries of origin. This notion
implies that apart from distinguishing products by their type (chemical, merchandize,
steel products), it is the place of production that enables treating the produced
products as imperfect substitutes. Yet, assumptions of similarities in preferences for
goods, in transportation expenditures and in structure of taxation pose significant
limitation on the usage of the theory.

45
R. J. Ball. The Economic Journal 77, no. 306, 1967: 366-68, accessed August 2, 2016,
https://www.jstor.org/stable/2229319?seq=1#page_scan_tab_contents

46
Edward E. Leamer and Robert M. Stern, Quantitative International Economics. Allyn and
Bacon International Series in Economics, USA, 1970, p 157-70, accessed September 2, 2016,
http://www.anderson.ucla.edu/faculty/edward.leamer/books/QIE/07percent20--
percent20Chapterpercent206.pdf.

47
Edward E. Leamer. “The Commodity Composition of International Trade in Manufactures:
An Empirical Analysis.” Oxford Economic Papers, New Series 26, no 3, 1974, accessed September 2,
2016, http://www.jstor.org/stable/2662292.
48
James E. Anderson. "A Theoretical Foundation for the Gravity Equation." The American
Economic Review 69, no. 1, 106-16, 1979, accessed August 10, 2016,
http://www.jstor.org/stable/1802501.

21
 Further contribution to theoretical explanation of the gravity model, which
incorporated product of countries GDPs as a rationale for explaining bilateral trade
flows, was developed by Helpman and Krugman (1985)49. They explained the gravity
model through monopolistic competition with an assumption of increasing returns to
scale. In their model products differentiation is not only limited to countries, but also
incorporates monopolistically competitive firms. According to the authors, the
traditional Hecksher-Ohlin comparative advantage theory does not provision
interrelation between bilateral trade and product of income of the trading countries, as
opposed to the gravity model. Deardorff (1984)50 likewise supported inclusion of
product of incomes, thereby supporting differentiated products model of trade, as data
provided proof of presence of this property. Later, however, Deardorff demonstrated
derivation of the gravity model from Hecksher-Ohlin theory, suggesting that either of
the theories could explain the empirical success of the gravity model.
At the same time, Bergstrand (1985)51 relied on a more relaxed utility function
assumption which enabled him to detect a close substitutability between the importing
products, unlike between importing and domestic goods. The equation was called
generalized gravity model due to inclusion of prices. Further Bergstrand (1990)52
supplemented the model with the idea of variances in relative factor endowment and
non-homothetic preferences.
At that point, although the gravity model to some degree acquired its
theoretical justification, the importance of distance was somewhat undermined. There
were, nevertheless, a few exceptions which considered the role of distance. For

49
Elhanan Helpman and Paul R. Krugman. Market Structure and Foreign Trade: Increasing
Returns, Imperfect Competition, and the International Economy, The MIT Press, Cambridge, MA:
Massachusetts Institute of Technology, London, 1985, accessed August 12, 2016,
https://www.scribd.com/doc/90616061/Helpman-krugman-1999-Market-Structure-and-Foreign-Trade
50
Alan V. Deardorff. “Determinants of Bilateral Trade: Does Gravity Work in a Neoclassical
World?” In Jeffrey A. Frankel (ed.) The Regionalization of the World Economy. NBER, Chicago:
University of Chicago Press, 7-28, 1998, accessed August 25, 2016, accessed October 1, 2016,
http://www.nber.org/chapters/c7818.pdf.
51
Jeffrey H. Bergstrand. “The Gravity Equation in International Trade: Some Microeconomic
Foundations and Empirical Evidence.” The Review of Economics and Statistics, Vol. 67, no. 3, August,
1965, 474-481, accessed August 20, 2016,
http://people.hss.caltech.edu/~camerer/SS280/gravitytrade.pdf.
52
Jeffrey H. Bergstrand. “The Heckscher-Ohlin-Samuelson Model, the Linder Hypothesis and
the Determinants of Bilateral Intra-Industry Trade.” The Economic Journal, Vol. 100, no. 403, 1216-
1229, December, 1990, accessed 17 August, 2016,
https://www.jstor.org/stable/2233969?seq=1#page_scan_tab_contents.

22
instance, in his theory of imperfect substitutes Bergstrand (1985) included distance as
a proxy shipping costs. Transportation costs are likewise incorporated in one of the
Deardorf’s (1977) Hecksher-Ohlin-based models. Further, Anderson and Wincoop
(2001, 2003) utilized properties of market clearing (i.e. supply equals demand) and
CES structure of demand to derive the gravity equation.

Linder vs Heckscher-Ohlin hypotheses

It is notable that two contrasting opinions concerning relationship between per
capita income and the volume of trade are still prevailing in theory of international
trade. For instance, Linder attributes difference between income per capita of trading
partners to discrepancies in preferences53. More specifically, Linder hypothesis states
that countries with identical levels of per capita GDP possess similar tastes and
produce similar but differentiated goods. Hence, according to Linder, greater
difference in per capita GDP, ceteris paribus, leads to lower trade between countries.
This hypothesis is in line with Helpman and Krugman theory, which associates
increase in distribution of per capita income of trading partners with more trade
between them. In term of analysis of the study, this indicates negative coefficient of
the variable. This is in direct contrast with the Heckscher Ohlin hypothesis which
assumes that the greater the difference of per capita income between trading partners,
the more trade would take place between them.

Literature review

Ever since Tinbergen the gravity model of international trade was applied in
many studies for various purposes. Although for a long period the model was widely
criticized for having no theoretical justification and yielding implausible findings,
gradually this issue was resolved. Perhaps one of the most contradictory findings in
the literature of the model is McCalum’s widely known outcome of “border puzzle”
or “home bias puzzle”54. The focus of the author’s analysis was on trade among
Canadian provinces and between Canadian provinces and US for the period 1994-96,
containing a total number of 3330 observations. Taking into account size of economy

53
Staffan Linder, “An Essay on Trade and Transformation”, Stockholm, March 1961, accessed
October 1, 2016, https://ex.hhs.se/dissertations/221624-FULLTEXT01.pdf

54
McCallum, J. "National Borders Matter: Canada-U.S. Regional Trade Patterns", The
American Economic Review, Vol. 85, No. 3, June, 1995, pp. 615-623, accessed October 4, 2016,
http://www.econ.ku.dk/nguyen/teaching/McCallumpercent201995.pdf

23
and distance, McCalum found Canadian intra province trade to be 22 times larger than
trade of the country with the US, suggesting that classical gravity model generates
misleading estimates of border effect on trade.
Later Anderson and Wincoop (2001) 55 proposed solution to the border puzzle.
They concluded that McCalum’s large coefficients were the product of omitted
variables bias and relatively small size of Canadian economy, which were not taken
into consideration. Another omitted issue was that Canadian provinces had a number
of informal cross-border trade barriers with the US56, unlike among themselves. Their
study highlights significance of including formal and informal trade barriers in the
gravity equation.
In another study Konkhartchank and Maurel (2003)57 analyzed the effect of
institutions on trade. Their aim was to estimate trade potential between the Central
Eastern European countries and the EU through gravity model. The authors’ findings
suggest that the CIS trade is distinguished by trade destruction effect, which, if
minimized, leads to an increase in trade with the EU countries. They likewise
highlighted conditionality of the positive impact of trade openness on trade to the
quality of institutions.
The gravity model was likewise applied to examine trade potential of Pakistan.
The State Bank of Pakistan targeted to analyze the trade of Pakistan at sectoral level
for the period 2002-2003 including 15 different sectors. Results of the study
demonstrate negative impact of conflict, as well as tariff and non-tariff barriers on
bilateral trade between Pakistan and India, thereby suggesting existence of significant
trade potential between the neighboring countries.

55
Anderson, J.E. and van Wincoop, E., ‘Gravity with Gravitas: A Solution to the Border
Puzzle’. American Economic Review 93(1), 170–192, 2003, accessed September 10, 2016,
https://www2.bc.edu/~anderson/BorderEffects.pdf

56
Jeffrey A. Frankel, Regional Trading Blocks in the World Economic System, October 1997,
p 118, https://piie.com/publications/chapters_preview/72/6iie2024.pdf

57
Babetskii, I., Kukharchuk, Oxana Babetskaia, and Raiser, M., "How deep is your trade?
Transition and international integration in Eastern Europe and the former Soviet Union", European
Bank for Reconstruction and Development, accessed September 19, 2016,
http://www.ebrd.com/downloads/research/economics/workingpapers/wp0083.pdf

24
 An analogous study financed by the World Bank was conducted by Baroncelli
(2007)58. The author attempted to estimate “peace dividend” and the impact of PTAs
had the two countries not been in hostility for more than fifty years. The dataset of his
study covered the years 1948-2000 and comprised of bilateral trade between 166
trading partners. The two dummies incorporated in the study were PTAs and
militarized conflict between Pakistan and India in certain years. As a result,
Baroncelli estimated that presence of conflict reduced bilateral trade between
neighbors by 474 million USD, which could have been added to the recorded trade of
117 million USD. In presence of the PTA the impact on trade was even more
encouraging. His study concluded that presence of conflicts significantly reduces
trade, while PTAs have positive impact on bilateral trade.
In the relating study, authors Jarko and Jan Fidrmuc (2003)59applied the
gravity model to investigate bilateral trade flows of the OECD countries (except
Iceland, Korea and Mexico) alongside certain Central and Eastern European countries
each year between 1990 and 1998. By applying cross sectional OLS, the authors
concluded that trade among Belarus, Ukraine and Russia follows a U shape form.
Whilst in 1992 bilateral trade between them was 43 times bellow prediction of the
model, already in 1998 countries traded 30 times above their potential.
Authors Batetskii I, Konkharchuk, O and M. Raiser (2003)60 also applied the
panel OLS estimator to estimate peculiarities of trade among 82 countries for the
period of six years (1997-2002). Their study suggests that countries of South-Eastern
Europe and the CIS trade considerably less with the rest of the world than with the 8
transition economies to access the EU in May 2004. Moreover, authors concluded that
the CIS countries trade 6 times higher among themselves, 31 percent of their actual

58
Baroncelli, E., “The “Peace Dividend,” SAFTA and Pakistan-India Trade,” in Naqvi, Z.F.
and Schuler, P. (Eds.), The Challenges and Potential of Pakistan–India Trade. Washington, DC: World
Bank, 2007, p 50-64, accessed August 10, 2016,
http://documents.worldbank.org/curated/en/990861468074627673/pdf/402730P07493901India1Trade0
1PUBLIC1.pdf
59
Jan and Jarko Fidrmuc, Review of International Economics, 2003, vol. 11, issue 5, pages
811-829, accessed September 20, 2016,
http://econpapers.repec.org/article/blareviec/v_3a11_3ay_3a2003_3ai_3a5_3ap_3a811-829.htm
60
Babetskii, I., Babetskaia, O., and Raiser, M., "How deep is your trade? Transition and
international integration in eastern Europe and the former Soviet Union", European Bank For
Reconstruction and Development, November 2003, accessed September 19, 2016,
http://www.ebrd.com/downloads/research/economics/workingpapers/wp0083.pdf

25
potential with EU and only 16 percent of the estimated potential with the rest of the
world.
By means of OLS and GLS estimators, Khatibi Arastou (2008)61 also applied
the gravity model to examine consequences of the WTO accession for Kazakhstan.
Focus of the author’s analysis was bilateral trade flows of Kazakhstan with respect to
its trading partners over the period 1995 to 2006. He then concluded that for
Kazakhstan gains from accession to the WTO will work best only when accompanied
with institutional reforms.
Study of Felipe J. and Kumar U. (2010), in turn, suggests that enhancing trade
facilitation generates considerable gains in trade among CA countries. For this study
authors applied Heckman Maximum Likelihood estimator. Their focus of observation
was trade among 140 countries in 2005, constituting 19, 460 observations.
Y. Guc and F. Suvankulov (2012) applied Panel OLS to study trade between
CA countries and their 5 major trade partners during the period 1996-2009. As a
result, authors came to a conclusion that export of Turkey and China to CA countries
exceeded its estimated trade potential.
Likewise, applying the gravity model, Kurmanalieva (2008)62 conducted an
empirical analysis of trade patterns of the Kyrgyz Republic. Her study was focused on
bilateral trade flows of Kyrgyzstan with 178 countries over the period 1996-2005.
Author’s findings suggest that policy of trade liberalization of the country has a
significant positive impact on trade.
In another study published in the same year Kurmanalieva together with
Papiev (2008) examined geographical focus of the Central Asian trade63. Their dataset
consisted of 171 countries covering the period 1997-2004. Applying the fixed effect
OLS estimator, the authors highlighted intra-industry character of trade among the CA
countries, distinguished by the level of natural resources endowment. Also, results

61
Arastou Khatibi, “Kazakhstan’s Accession to the WTO: A Quantitative Assessment,”
ECIPE Working Paper No. 02/2008, Belgium, 2008, accessed September 15, 2016
http://ecipe.org/publications/kazakhstan2019s-accession-to-the-wto-a-quantitive-assessment/

62
Elvira Kurmanalieva, "Empirical Analysis of Kyrgyz Trade Patterns" Eurasian Journal of
Business and Economics 2008, 1 (1), 83-97, accessed September 10, 2016,
http://www.ejbe.org/EJBE2008Vol01No01p83KURMANALIEVA.pdf

63
Elvira Kurmanalieva and Ziyodullo Parpiev, "Geography and Trade in Central Asia",
January, 2008, accessed September 12, 2016,
https://www.academia.edu/3732006/Geography_and_Trade_in_Central_Asia .

26
indicate that notwithstanding the increasing trade with the rest of the world, intra-
regional trade of CA countries within the CIS manifested a falling tendency. Authors
also noted that the decrease in trade was both in absolute and relative terms.
Further study of the author in joint effort with Vinokurov (2011)64 expanded
the scope of initial analysis to the intra-regional trade among the CIS countries. Their
dataset comprises 162 countries for the period 1995-2008. Authors conclude that trade
within CIS is 4.5-10 times above its predicted level.
Recently similar study was conducted by Naktova (2016)65. The author
analyzes the impact of EurAsEc on trade in Tajikistan. She applies the fixed effect
OLS estimator in order to examine bilateral trade of the country with respect to 26
trade partners during 1995-2013. Her study suggests positive consequences of
Tajikistan’s accession to the EurAsEC. As it can be inferred from the study,
membership only led to trade creation with no implications of trade diversion.
Finally, Sugaipova (2015)66 utilized the gravity model in order to quantify the
impact of the EAEU accession on its member states. In doing so, she applied the
PPML technique, making sure to compare its results with the alternative pooled and
panel OLS estimators. Her main conclusion was that EAEU membership increased
the countries’ trade flows by approximately 150 percent.
The above studies investigate the importance of trade facilitation, PTAs and
economic integration for trade through applying the gravity model of international
trade. Substantial number of other studies also applied the gravity model for various
purposes. In the framework of this study it was reasonable to limit the focus of
analysis of existed literature to the CIS countries. In this regard, brief summary of
researches conducted for the region with application of the gravity model is proved in
the Table 1 enclosed in the Appendix.

64
Elvira Kurmanalieva and Eugeny Vinokurov, "Holding Together or Falling Apart: Results
of Gravity Equation of the CIS trade" Eurasian Development Bank, June 2011, accessed September 18,
2016, https://mpra.ub.uni-muenchen.de/32003/1/MPRA_paper_32003.pdf .

65
Nakatova, Mohbonu, "Trade Effects of Regional Economic Integration in Tajikistan: The
Case of EurAsEC," August 23, 2016, accessed September 12, 2016,
https://minerva.usc.es/xmlui/handle/10347/14852.

66
Maryam Sugaipova, “Eurasian Economic Union, Regional Integration and the Gravity
Model,” University of Oslo, January 2015, accessed August 5, 2016,
https://www.duo.uio.no/bitstream/handle/10852/43862/Maryam-Sugaipova-.pdf?sequence=1.

27
 CHAPTER IV: METHODOLOGY AND DATA DESCRIPTION
Description of Methodology

As it can be inferred from the previous section, the gravity model has been
widely applied in practice and refined with expanding the range of factors influencing
trade. In this regard, apart from applying the gravity model in its classical log
linearized form presented by Tinbergen, the focus of this study was to incorporate the
augmented version of the model. For instance, in addition to traditional gravity
variables, such as GDP of trading partners, distance, adjacency and PTAs, the
advanced version includes per capita GDP, absolute value of per capita GDP
differentials, real exchange rate (REER), corruption, cost to import/export (which
include trade related documentation expenses), as well as burden of customs
procedures. Likewise, dummy variables such as common language, history and FTA
were supplemented into the equation to analyze whether sharing common linguistic
links or history and presence of FTAs influence bilateral trade. Hence, the final log
linearized equation took the following form:
𝑙𝑛 (𝑇𝑘𝑗 ) = (𝛽0 ) + 𝛽1 𝑙𝑛(𝑌𝑘 ∗ 𝑌𝑗 ) + 𝛽2 𝑙𝑛(𝑃𝐶𝑌𝐷) + 𝛽3 𝑙𝑛(𝐷𝑘𝑗 ) + 𝛽4 𝑙𝑛(𝐸𝑘𝑗 ) + 𝛾𝑍𝑘𝑗
+ 𝑙𝑛 (𝑢𝑘𝑗 )
(𝑇𝑘𝑗 ) – bilateral trade in USD (represents amount of export and import both
individually and combined)
𝑌𝑘 ∗ 𝑌𝑗 – product of GDPs of the trading partners
PCYD – difference in income of countries in trade
𝐷𝑘𝑗 – distance between trading partners
𝐸𝑘𝑗 – indicator of economic and institutional factors which potentially affect
trade (real exchange rate, corruption, cost to import/export, burden of customs
procedures)
𝑍𝑘𝑗 – stands for quantitative variables to control for adjacency, PTAs,
common language and history
At this point, it is notable that the log linearized gravity model has become
subject of scrutiny for some reasons. In particular, a few important issues arise while
dealing with the standardized gravity model. It is problematic, for instance, to include
cases of zero trade flows, which are quite common in international trade, into the log-
linearized equation.

28
 Furthermore, it has been argued that presence of heteroscedasticity in the log-
linearized gravity model challenges unbiasedness and consistency assumption of the
estimator. More specifically, reliability of the results of the regression depends on
fulfilment of certain assumptions concerning the normally distributed residual. These
assumptions include presence of constant mean (E (𝑢𝑘𝑗 ) = 𝜇) and constant variance
(var (𝑢𝑘𝑗 ) = 𝜃 2 ). In this respect, the study of Silva and Tenreyro (2006)67
demonstrated that due to presence of heteroscedasticity, which is common in gravity
model, log linearization of the gravity model generates unreliable results. Since the
expected value of the residual, as well as its variance, is no longer constant under
heteroscedasticity, the error term becomes function of the explanatory variables. To
better understand why this is the case it suffices to recall that in case of
homoscedasticity the expected value of the error term undertakes the form E
(𝑢𝑘𝑗 |𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 ) = 1, indicating its independency form the regressors.
Rewriting the basic equation in form of log would adjust the model as follows:
𝑙𝑛(𝑇𝑘𝑗 ) = lnG + ln𝐻𝑘 +𝑙𝑛𝑀𝑗 + 𝑙𝑛𝜑𝑘𝑗 +𝑙𝑛𝑢𝑘𝑗
Taking condition expectation would result in:
𝐸(𝑙𝑛(𝑇𝑘𝑗 )|( 𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 )) = 𝐸(ln (𝑇𝑘𝑗 )|lnG + ln𝐻𝑘 +𝑙𝑛𝑀𝑗 + 𝑙𝑛𝜑𝑘𝑗 + 𝑙𝑛𝑢𝑘𝑗 )
The additive property of the expected value would result in:
𝐸(𝑙𝑛(𝑇𝑘𝑗 )|( 𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 )) = 𝐸(ln (𝑇𝑘𝑗 )|lnG + ln𝐻𝑘 +𝑙𝑛𝑀𝑗 + 𝑙𝑛𝜑𝑘𝑗
+ 𝐸(ln (𝑢𝑘𝑗 )|( 𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 ))
The above equation would generate consistent and unbiased result under
strict condition that the expected value of the residual, given the other explanatory
variables, is equal to zero. In this respect, since (𝑢𝑘𝑗 |𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 ) = 1, taking log of
this equation would produce zero. Yet, Jasen’s inequality suggests that due to
presence of heteroscedasticity interpretation of the coefficients of the log linearized
model as elasticities would be no longer meaningful. More precisely, this would lead
to 𝑙𝑛(𝐸(ln (𝑢𝑘𝑗 )|( 𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 )) ≠𝐸(ln (𝑢𝑘𝑗 )|( 𝐻𝑘 , 𝑀𝑗 , 𝜑𝑘𝑗 )) , implying that the
value of the logarithm of the expected residual would be different than that of the
expected value of its logarithm.

67
Santos Silva and Silvana Teneyro, “The log of gravity,” The Review of Economics and
Statistics, 88 (4) p 641-653, accessed September 21, 2016,
http://personal.lse.ac.uk/tenreyro/jensen08k.pdf.

29
 In this respect, Joao Santos Silva and Silvana Tenreyro in their study proved
that taking the log of gravity yields biased coefficients of the explanatory variables,
even when controlling for the fixed effects. According to the authors, this problem
can be avoided if trade flows would be calculated in levels, rather than in logs.
Hence, they propose to estimate the gravity model by means of two alternative
methods, namely nonlinear least squares (NLS) and Poisson Pseudo Maximum
Likelihood (PPML) estimators, preferring the latter method to the former.
Consequently, apart from becoming natural solution to the zero trade flows, Monte
Carlo simulations68 revealed that the proposed method also proved to be reliable
under various patters of heteroscedasticity. Moreover, the PPML does not require its
explanatory variables to be distributed in levels and allows interpreting coefficients
of the regressors the same way as under the log linearized model, which make usage
of the method quite practical. Hence, application of the gravity model in this study
would rely only on the results generated by the PPML estimator.

Description of data
For comparative purpose bilateral trade is observed with respect to 52 (for the
Kyrgyz Republic) and 50 (in case of Tajikistan) top trading partners of the two post-
Soviet states during 21 years of independence (1995-2015). Figure 8 illustrates
trading partners of both countries under examination.
Figure 8. Visual illustration of trading partners of Kyrgyzstan and Tajikistan
countries included in the analysis.

Kazakhstan Afghanistan
Bulgaria Denmark Georgia
Australia Austria Belarus Estonia Germany Israel
Ireland Azerbaijan Canada Finland Greece Italy Armenia
Malaysia Czech Rep China France Hungary Japan Belgium
Mexico Pakistan Slovakia UAE India Korea Kyrgyzstan
Sri Lanka Poland Slovenia UK Turkey Latvia Portugal
Thailand Romania Spain Ukraine Turkmenistan Lithuania Vietnam
Tajikistan Russia Sweden USA Netherlands
Switzerland Uzbekistan Norway
Moldova Iran Singapore

The left hand oval includes major trade partners of the Kyrgyz Republic, while
the right hand oval contains chief trade partners of Tajikistan. As it can be inferred

68
Monte Carlo simulations enable an investigator to generate hypothetical dataset and to
choose the most appropriate model among the existed alternatives, which would allow drawing
reasonable conclusion on the principal structure of the on-hand data.

30
from the figure, both Kyrgyzstan and Tajikistan mostly trade with the same group of
countries.
Moreover, an additional observation was conducted for the Kyrgyz Republic
to check the validity of regression coefficients. Thanks to the availability of trade
statistics, the number of observations was increased to 168 trading partners covering
the period of 15 years (2001-2015). Complete list of variables incorporated in the
analysis of the gravity model of international trade is as follows:
a) Log of GDP – is in current USD and contains log of product of GDPs
of Kyrgyzstan and Tajikistan with trading partners for the period 1995-2015. Data is
extracted from the World Bank collection of development indicators (WDI). The
expected sign of this variable is positive;
b) Log of GDP per capita – is in current USD and includes log of
product of PCGDPs of Kyrgyzstan and Tajikistan with trading partners for the period
1995-2015. Data is extracted from the WDI. The expected sign of this variable is
positive.
c) Log of PCGDPD – expressed in form of absolute value, per capita
GDP differentiation indicates difference in per capita income of trading partners. The
data is based on the value of per capita GDP extracted from the WDI. This variable
was incorporated in the analysis to check whether bilateral import of trading partners
follow Linder or Heckscher-Ohlin hypothesis. In this respect, no prediction would be
made with respect to the expected sign.
d) Trade Openness – is represented in percentage and comprises of
merchandize trade turnover divided by GDP in current USD for the period 1995-
2015. Data is extracted from the WDI;
e) Corruption – indicates perception of institutions quality and is
measured in index for the period 1998-2015. Data is taken from the annual
publications of Transparency International (available at
https://www.transparency.org/cpi2015/). Expecting sign of the variable is positive,
implying that improvement in the quality of institutions, ceteris paribus, promotes
trade.
f) Real effective exchange rate (REER) – is an index measuring the real
value of currencies of countries under consideration against the basket of their
trading partners for the period 1995-2015; an increase in index indicates appreciation
of home country currency and vice versa. The data is collected from the Bruegel

31
dataset website (reached at http://bruegel.org/publications/datasets/real-effective-
exchange-rates-for-178-countries-a-new-database/ ). Expected sign of the variable
depends on whether import or export flows are subject of analysis. In case of import
flows, expected sign of home country REER is positive, while the sign of partner’s
REER coefficient is anticipated to be negative. The reverse is true for export flows.
g) Cost to import/export – indicates official fees levied on a 20-foot
container in USD. Fees comprise all expenses necessary for completing the
procedures to import/export the goods, except tariffs or trade taxes. This include
costs for documents, administrative fees for customs clearance and technical control,
customs broker fees, terminal handling charges and inland transport. Data is
extracted from the WDI. Expected signs of these variables are negative.
h) Burden of customs procedure – indicates how business executives
perceive efficiency of customs procedures in their country. The rating of efficiency
ranges from one to seven. The measure is then converted to percentage in order to
better fit into the log linearized equation. The data is extracted from the WDI.
Expected sign of burden of customs procedure is positive, implying that increase in
efficiency of customs checks lead to more trade between countries.
i) Adjacency – is a dummy variable taking the value one if partners
share common border and zero otherwise. Expected value for contingency is
positive.
j) Landlockedness - is a dummy variable taking the value one if the
trading partner is landlocked and zero otherwise. The data was collected from the
CEPII database (reached at http://www.cepii.fr/CEPII/en/bdd_modele/bdd.asp).
Expected sign of this variable is negative.
k) EAEU Customs Union and later Economic Union - is a dummy
variable taking the value one in case of membership of the trading partner in the
Union and zero otherwise. Expected sign of the EAEU coefficient is positive.
l) History - is a dummy variable taking the value one if trading partners
share common history and zero otherwise. Expected sign of this variable is positive.
m) Language - is a dummy variable taking the value one if trading
partners speak common language and zero otherwise. The data was collected from
the CEPII database. Expected sign of speaking common language is positive.

32
 n) CIS (including Georgia, Uzbekistan and Turkmenistan) - is a dummy
variable taking the value one in case of membership of the trading partner and zero
otherwise. Expected valued of the CIS coefficient is positive.
o) Export – stands for total bilateral export of goods in USD and in case
of PPML estimation converted to the scale of million USD.
p) Import – is total bilateral import of goods in USD; in order to avoid
scaling issues, estimation the import value is in million USD.
Nonetheless, due to limitation of data on economic indicators, bilateral trade
with twenty trading partners was omitted from the analysis, thus reducing the number
of final observation to 148 countries (for the complete list of trade partners please see
Table 2 in the Appendix).
In the framework of this study, it is notable that since both Kyrgyzstan and
Tajikistan were part of the Soviet Union and had Russian as official state language
for many years, practicing same language would be mostly explained by having
common history. Nevertheless, mainly past colonial ties enabled the post-Soviet
states to inherit common customs procedures, linked trade infrastructure, similar
documentations and other relating cross-border requirements which have eventually
served for reducing technical barriers to trade. In this respect, it is reasonable to
compare whether historical ties or sharing common language more accurately
explains trade patter of the countries of interest.
Last but not least, it is also necessary to avoid inclusion of multiple FTAs in
the regression at once. While the EAEU and its predecessor EurAsEC comprise of 5-
6 countries, the same set of countries are also part of the CISFTA. This necessitates
comparing explanatory power of the trade agreements in separate in order to avoid
overlap between FTAs.

33
 CHAPTER V: DISCUSSION OF RESULTS
This section provides detailed discussion of the results obtained from
applying the gravity model of international trade with the PPML estimator. Note that
import and export subsections differentiate outcomes for the two categories of trade.

Investigation of import flows

Augmented analysis of the gravity model revealed significant positive

relationship between the value of import of the Kyrgyz Republic and GDP of its
trading partners. In particular, one percent increase in the GDP of the exporting
country accounts for 2.6 percent increase in the value of import. The coefficient is
significant at 1 percent. Interestingly, another traditional variable of the model,
namely home country GDP, although with the expected positive sign of the
coefficient, could not explain the dependent variable at 95 percent confidence
interval. Visual illustration of this relationship is provided in the figure 9. As it can
be inferred from the figure, value of GDP of the Kyrgyz Republic is less volatile
compared to its trade trends.

Figure 9.Trend of home country GDP and external trade for the period 1995-
2015
Import Export GDP

10000.00

8000.00

6000.00

4000.00

2000.00

0.00
95 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Source: calculations are based on WDI and ITC data

Coefficient of distance was negative and significant at 5 percent, implying

that one percent increase in distance between the trading partners decreases import
by 1.62 percent. Variation in the real exchange rate of the Kyrgyz Republic likewise
showed positive and significant relationship at one percent. More specifically,
percentage increase in the exchange rate of the Kyrgyz Som brings about 3.1 percent

34
increase in the value of import. Trade openness likewise revealed that one percent
increase in trade openness, holding other things equal, boosts import by 2 percent.
The coefficient of contingency suggests that trade with countries with which
Kyrgyzstan does not share common border is approximately 60 percent less
[100*(exp (-0.91) -1)]. Sharing common history demonstrates even greater elasticity,
implying that the value of trade is 91 percent less with countries which do not share
common history with the Kyrgyz Republic. Although these results should be
interpreted with caution, they illustrate general picture of significance of history and
contingency when it comes to trade.
Nonetheless, taking into account the unusual high coefficients of dummy
variables, of particular interest was to check the reliability of the generated results.
Significance of historical ties was expected to be considerably exaggerated by the
reintegration initiatives of some post-Soviet states and existence of bilateral free
trade agreements among the CIS member states. Hence, it was reasonable to increase
the number of observation of the bilateral trade flows of the Kyrgyz Republic from
initial 52 major trading partners to 148 countries. Visual illustration of the share of
import partners of the country by the former Soviet states, which includes member
states of the CIS and EAEU, is presented in figure 10.

Figure 10. Share of total import of the Kyrgyz Republic for the period 1995-
2015 (in million USD)
EAEU CIS FSU Total import

6000

4000

2000

0
95 0 1
2 3 4 5 6 7 8 9 10 11 12
13 14 15

Source: calculations are based on International Trade Statistics dataset.

As it can be inferred from the figure, import form the former Soviet states
accounts for almost 60 percent of the total import of the country. Share of import by

35
the non-CIS former Soviet Republics appears to be equally important as that of the
CIS trading partners. Therefore, coefficient of history showed little improvement
both with and without observation of import flows from the CIS countries.
Nonetheless, when excluding the CIS countries form the observation,
variations in the GDP of the Kyrgyz Republic manifested explanatory power at 5
percent. In particular, percentage increase in the GDP of the Kyrgyz Republic,
holding other things constant, leads to 1, 4 percent increase in trade with non-CIS
countries.
Interestingly, however, once the number of observations was increased,
negative relationship between imports and real exchange rate of the exporting
country obtained significant explanatory power. More precisely, a percentage
increase in real exchange rate of trading partner of Kyrgyzstan, ceteris paribus,
appears to decrease import by 1.9 percent. Conversely, elasticity of import with
respect to a percentage increase in real exchange rate of the Kygyz Som turned out to
have little impact on import (please refer to the Appendix for more details).
Other qualitative variables such as membership in the CIS, EAEU, being
landlocked and having common language showed little explanatory power while
controlling for history. Results of separate regressions likewise emphasized
significance of sharing common history over CIS and EAEU.
In contrast, export costs of trading partners of the Kyrgyz Republic appear to
decrease trade of the country by 1, 1 percent. The sign of the coefficient is negative
and significant at 1 percent, which highlights the negative impact of imposed export
fees on trade.
As anticipated, the effect of including other explanatory variables to the
gravity equation was less effective. Level of corruption, although with the expected
sign, did not show significant explanatory power on Kyrgyzstan’s import. This could
be explained by the fact that perception of quality of institutions is a relative
measurement and could not be free from human factor. Similar reasoning could also
explain negative and significant relationship between customs burden and import.
Note that this indicates 5, 8 percent decrease in import to the Kyrgyz Republic,
ceteris paribus, if perception of efficiency of customs procedures increases by one
percent. In this respect, any interpretation of the impact of such indices should be
performed with caution.

36
 In case of Tajikistan, estimation revealed that percentage increase in GDP of
its trading partner leads to 2.5 percent increase in import. Similar to the case of the
Kyrgyz Republic, home country GDP also does not have explanatory power.
Percentage increase in distance between the trading partners, in turn, decreases the
flow of import by 1, 6 percent.
Whilst variation in real exchange rate of the Tajik Somoni showed no
explanatory power, increase in real exchange rate of its trading partners appears to
increase import by 1, 8 percent. Such unexpected sign could be attributed to
significant dependency of the country, although with decreasing tendency, on import
with the existed poor export capacity. Visual illustration of trade of the country
compared to its GDP is presented in the figure 11.

Figure 11.Trend of trade and GDP of Tajikistan during the period 1995-2015.
10000

8000

6000 Overall Import

4000 Export
GDP
2000

0
95 97 99 1 3 5 7 9 11 13 15

Source: calculations are based on data extracted from the WDI and Statistical
Agency under the President of the Republic of Tajikistan.

Under such conditions, appreciation of partner’s real exchange rate means

paying more for the same value of import and does not necessarily imply increase in
demand. What can be inferred from such results is that an increase in real exchange
rate of the exporting country decreases demand to somewhat lesser extent.
Trade openness of the export partners of Tajikistan also seems to
significantly impact its imports. In particular, percentage increase in trade openness
of its trading partners increases import of the country, ceteris paribus, by 1, 83
percent.
Coefficient of history likewise stood out for this country, although with a
lesser extent. According to the estimation, the value of import decreases by 89
percent if imported from trading partners with which Tajikistan does not share

37
common history. Figure 12 demonstrates visual illustration of share of import to the
country.

Figure 12. Share of total import of Tajikistan for the period 1995-2015 (in
million USD)
EAEU CIS FSU Total Import

6000

4000

2000

0
95 0 1 2
3 4 5 6
7 8 9
10 11 12
13 14 15

Source: author’s calculations, based on publications of the Agency of

Statistics under the President of the Republic of Tajikistan

As it can be inferred from figure 12, Tajikistan’s trade with the FSU
Republics is slightly more significant than in case of the Kyrgyz Republic. In terms
of ratio, an average of 65 percent of all import to the country accounts for countries
with which it has common historical links.
Relationship between export costs of Tajikistan’s trading partners and flow of
import to the country was also negative, implying, ceteris paribus, 1.4 percent
decrease in import. Its coefficient was also negative and significant at 1 percent,
which highlights significance of the result.
In contrast, control for contingency and landlockedness did not possess
significant explanatory power. Minor impact of sharing common border on import
could be attributed to long-lasting instability in Afghanistan and unstable political
relationship with Uzbekistan, which considerably impede bilateral trade. At the same
time, insignificant impact of contingency on both countries could be explained by the
fact that the two post-Soviet states are surrounded mostly by other landlocked
countries.
Performance of the two perception indices was also not straightforward.
Burden of customs procedures demonstrated clear positive relationship between
import and more efficient customs indicators. On the contrary, decrease in corruption

38
manifested the opposite effect, which was likewise significant. In this respect, since
these two regressors are based on relative assessment and generate contradictory
impacts on the trade flows of the two countries, it becomes reasonable to exclude
them from further analysis.

Test for Linder vs Heckscher-Ohlin hypotheses

As mentioned earlier, coefficients of per capita GDP differentiations of trading
partners were included in the analysis in form of absolute value in order to test the
relevance of Linder and Heckscher Ohlin hypotheses by empirical assessment. In both
cases coefficients of these variables were negative but did not bear explanatory
power. It can be, therefore, concluded that import flows of the two countries neither
follow Linder nor Heckscher-Ohlin hypotheses.

Analysis of export flows

Unlike the data on import flows which was close to the fitted line of the
gravity regression, coefficient of determination of export flows were as low as 10
percent for the Kyrgyz Republic and 6 percent for Tajikistan. In addition, hardly any
regressor was able to explain the dependent variable at 95 percent confidence
interval. Such results indicate that gravity model is not the best choice for explaining
export flows of the two countries. Alternatively, it is possible to introduce certain
instrumental variables to the model and to check for the outcomes.
In the scope of this research for better comprehension of the reasons behind
incapability of the gravity model to explain flows of export, it is essential to look at
changes in export patterns of each country. Visual illustrations of the share of export
of the two countries are provided in figures 13 and 14.
It can be inferred from the figure 13 that share of export patterns of the
Kyrgyz Republic slightly differ from that of the import in that FSU countries account
for lesser share of export from the country. Yet, the difference of ten percent is not
significant enough to explain the inappropriateness of the gravity model. More
precisely, considerable share of the FSU countries is in line with the assumptions of
the gravity model, which attributes economic mass and distance of trading partners
as one of the main determinants of trade value.

39
 Figure 13.Share of export of the Kyrgyz Republic

2000

1000

0
95 0 1 2 3
4 5 6 7 EAEU
8 9 10 11
12 13 14
15

EAEU CIS FSU Total Export

Source: calculations are based on data from ITC, UNCTAD trade statistics
and National Statistics of the Republic of Kyrgyzstan

At this point, it is reasonable to compare these indicators with share of export

flows of the neighboring country. As it can be inferred from the figure 14, from the
total export flows of Tajikistan, only an average of 20 percent is directed towards the
FSU countries. Sudden decrease in export flows to the FSU countries can be
observed since 2000, when almost fifty percent of the whole export was directed
towards markets of the FSU Republics.

Figure 14.Share of export of the Republic of Tajikistan (in million USD)

2000

1000

0
95 0 1 2 3
4 5 6 7 EAEU
8 9 10 11
12 13 14
15

EAEU CIS FSU Export

Source: author’s calculations are based on publications of Agency of

Statistics under the President of the Republic of Tajikistan

It appears that visual illustrations of the share of exports of the two countries
provide incomplete explanation for the reasons behind incapability of applying the
gravity model of international trade. Hence, this study would limit itself with
attributing changes in export flows of the two countries only to supply and demand
and to variations in price of their chief export commodities.

40
Trade potential of Kyrgyzstan and Tajikistan: Comparative analysis

Since predicted trade estimated with the gravity model is subject to statistical
uncertainty and measurement flaws, its results should be interpreted with caution. In
the framework of this thesis estimation of trade potential is presented to give a general
idea of the actual situation. Following the gravity model, analysis of differences
between actual and predicted imports of the Kyrgyz Republic and Tajikistan during
21 years enabled to estimate to what degree the two countries fulfill their trade
potential (more detailed version of trade potential estimation for both countries is
provided in the Table 11 enclosed to the Appendix). Figure 15 illustrates the list of
major import partners of the Kyrgyz Republic with an estimate of possible scope for
increase in trade. Note that for both countries only estimators with significant
explanatory power were incorporated in the analysis.

Figure 15.Untapped trade potential of the Kyrgyz Republic in 2015 (in million
USD)

China
Uzbekistan
USA
India
Germany
UK
Turkmenistan
France
Tajikistan

Source: author’s calculations

As it can be concluded from the figure, there are a number of countries with
which Kyrgyzstan has clear potential to increase its trade. Analysis of actual and
predicted import enabled to detect sudden increase in untapped trade potential of the
Kyrgyz Republic with several countries. For instance, although actual trade with
China was far above its forecast till 2013, constituting 333.8 million above potential,
in one year amount of imports fell to 69.4 million below the predicted level. As of
2015 trade with China could have been 135.6 million more than the registered level.
Similarly, since 2011 trade with Uzbekistan has been steadily decreasing.
Import from this country even fell twice bellow its predicted value in 2015 compared

41
to the year earlier, constituting 110.3 million USD unrealized trade potential. Trade
also fell far below its predicted value with Netherlands. Compared to 4 million
unrealized trade potential in 2014, the year after the scope of unrealized trade
increased to 19.6 million. In addition, although trade with Japan was fulfilling its
estimated potential since 2008, in 2015 the difference between actual and predicted
trade constituted 17 million. These results imply that certain external circumstances
held back trade with these countries which value could have otherwise been above the
registered level.
To compare, analysis shows that since 2008 trade between Tajikistan and
Uzbekistan is far below its potential. As of 2015 the value of import from Uzbekistan
could be 349.7 million USD more than its existed level. Figure 16 illustrates
significant scope of expansion of trade for Tajikistan with some of its chief trading
partners.
Figure 16.Untapped trade potential of Tajikistan in 2015 (in million USD)

Uzbekistan
India
Azerbaijan
UK
Czech Republic
Germany
USA
Israel

Source: author’s computations

While the existed considerable unrealized trade potential between Tajikistan
and Uzbekistan could be attributed to political issues between the two neighboring
countries, no significant volatilities in trade potential were observed in case of
Tajikistan. In other words, difference between actual and predicted trade of the
country was relatively constant. Sudden changes in proportions of realized and
unrealized trade potential of the Kyrgyz Republic, in turn, could be explained by
accession of the country to the EAEU, which brought about an increase of importing
tariffs levied on the products from non-EAEU member states. With respect to trade
of the Kyrgyz Republic with Kazakhstan (which is also member of the EAEU), for
instance, predicted trade fell far below its actual value as short as in one year. As a

42
result, compared to the long-lasting unrealized trade potential between the two
countries since 2006, difference between actual and predicted import flow from
Kazakhstan became 250.7 million in 2015, unlike the -252.8 million in 2014.

43
 CONCLUSION
Dissolution of the Soviet Union and subsequent decay of once common
market challenged the existing trade links of the Kyrgyz Republic and Republic of
Tajikistan. This combined with subsequent inflation after gaining independence
brought about scarcity of necessity goods and severe dependence on import during the
initial period. Since then, the two post-Soviet states have followed the path of trade
liberalization, which allowed them to actively engage in various regional integration
initiatives. The most recent product of regional integration is the EAEU. Whilst
Kyrgyz Republic is full member of the economic integration since August 2015,
Tajikistan is in the stage of assessing the impacts of prospective integration.
Besides, accession of the two countries to the World Trade Organization
indicates openness of their trade not only with other members of regional integrations
but also with respect to the rest of the world. Nonetheless, having applied the gravity
model of international trade, it becomes evident that historical ties continue remaining
the main determinants of the two countries’ import flows. More specifically, the value
of import from countries which do not share common history with the Kyrgyz
Republic and Republic of Tajikistan is up to 92 percent and 89 percent less than with
the post-Soviet states. Such high coefficients are in line with findings of similar
studies. It appears that historically established trade links and trade infrastructure
alongside similarities in customs procedures and common language continue
dominating among other trade-promoting factors. Hence, further regional integration
initiatives should consider expanding the scope of integration and preferential
treatment with other former-Soviet Republics not included in the CIS.
Other variables which positively affect import flows of the Kyrgyz Republic
are GDP and trade openness of its trading partners, domestic real exchange rate,
contingency and regional integrations. In contrast, distance and partners’ export costs
have a negative influence on import flow to the Kyrgyz Republic.
At the same time, additional determinants which positively influence import
flows in case of Tajikistan are trading partner’s GDP, partner’s real exchange rate,
regional integrations and partner’s trade openness indicator. Distance between trading
partners and import cost, in turn, cause significant negative impact on trade.
The gravity model also identifies existence of significant trade potential of the
Kyrgyz Republic with China, Uzbekistan, United States, India, Germany and United

44
Kingdom among others. In case of Tajikistan, the list comprises Uzbekistan, India,
Azerbaijan, United Kingdom, Czech Republic and others.

45
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50
 APPENDIX
Table 1.Summary of the literature review for the CIS countries
Author(s) Estimator Dataset Results
Fidrmuc J., Cross Bilateral trade flows of Trade among Belarus, Ukraine and
Fidmurc J. sectional OECD countries (except Russia follows a U shape form.
(2003) OLS Iceland, Korea and Whilst in 1992 bilateral trade
Mexico) together with between them was 43 times bellow
selected Central and prediction of the model, already in
Eastern European 1998 countries traded 30 times
countries each year above their potential.
between 1990 and 1998
Babetskii I, Panel OLS Trade of 82 countries South-eastern Europe and the CIS
Koukhartch during six years (1997- trade considerably less with the rest
O. and 2002), generating 39,852 of the world than with the 8
Raiser, M observations transition economies to access the
(2003) EU in May 2004.
Khatibi, A. OLS and 34,763 observations for For Kazakhstan gains from
(2008) GLS Kazakhstan covering the accession to the WTO will work
period 1995 to 2006 best with complementary
institutional reforms.
Kurmanaliev Panel OLS Bilateral trade of Policy of trade liberalization of the
a, E (2008) Kyrgyzstan with 178 Kyrgyz Republic has a significant
countries over the period positive impact on trade
1996-2005
Kurmanaliev Fixed Their dataset consisted of Despite the increasing trade with
a E. and effects OLS 171 countries covering the rest of the world, intra-regional
Papiev Z. the period 1997-2004. trade of CA countries within the
(2008) CIS manifested a falling tendency
Felipe J., Heckman 140 countries, 19,460 Enhancing trade facilitation
Kumar U. Maximum observations for 2005 generates considerable gains in
(2010) Likelihood trade for CA countries.
Guc Y, Panel OLS Trade between CA Turkey and China exported to CA
Suvankulov countries and their 5 countries beyond their trade
F. (2012) major trade partners potential.
during 1996-2009
Sugaipova, PPML Bilateral trade of EAEU membership boosts the
M. (2015) Belarus, Russia and countries’ trade flows by
Kazakhstan with 45 approximately 150percent.
countries over 4 years
Naktova, M Fixed 26 trade partners of Tajikistan’s accession to the
(2016) effects OLS Tajikistan during 1995- EurAsEC only led to trade creation
2013. with no implications of trade
diversion.

51
 Table 2. Full list of trading partners of the Kyrgyz Republic included in the
analysis

Afghanistan Benin Iran, Islamic Rep.

Albania Bermuda Ireland
Algeria Bhutan Israel
Angola Bolivia Italy
Argentina Bosnia and Herzegovina Jamaica
Armenia Botswana Japan
Australia Brazil Jordan
Austria Brunei Darussalam Kazakhstan
Azerbaijan Bulgaria Kenya
Bahamas Cambodia Korea, Rep.
Bahrain Canada Kuwait
Bangladesh Chile Lao PDR
Barbados China Latvia
Belarus Colombia Lebanon
Belgium Congo, Dem. Rep. Liberia
Belize Congo, Rep. Libya
Costa Rica France Lithuania
Cote d'Ivoire Georgia Luxembourg
Croatia Germany Macedonia, FYR
Cuba Greece Madagascar
Cyprus Greenland Malawi
Czech Republic Grenada Malaysia
Denmark Guatemala Maldives
Dominica Guinea-Bissau Mali
Dominican Guyana Malta
Republic
Ecuador Haiti Marshall Islands
Egypt, Arab Rep. Honduras Mauritius
El Salvador Hong Kong SAR, China Mexico
Estonia Hungary Moldova
Ethiopia Iceland Mongolia
Faroe Islands India Morocco
Finland Indonesia Mozambique
Nepal Romania Sweden
Netherlands Russian Federation Switzerland
New Zealand Rwanda Tajikistan
Nicaragua Saudi Arabia Tanzania
Niger Senegal Thailand
Nigeria Serbia Tunisia
Norway Seychelles Turkey
Oman Sierra Leone Turkmenistan
Pakistan Singapore Uganda
Panama Slovak Republic Ukraine

52
Paraguay Slovenia United Arab
Emirates
Peru Solomon Islands United Kingdom
Philippines South Africa United States
Poland Spain Uruguay
Portugal Sri Lanka Uzbekistan
Qatar Suriname Venezuela, RB
Yemen, Rep. Zambia Vietnam
Zimbabwe

53
 Table 3. Results of the PPML regression for the Kyrgyz Republic (52 trading
partners)

Table 4. Results of the PPLM Regression for Kyrgyzstan (supplemented

variable: corruption)

54
 Table 5. Results of the PPML Regression for Kyrgyzstan (supplemented
variable: export cost)

Table 6. Results of the PPML regression for the Kyrgyz Republic (all trading
partners)

55
 Table 8. Results of the PPML regression for Tajikistan (50 trading partners)

Table 9. Results of the PPML regression for Tajikistan (supplemented variable:

corruption)

56
 Table 10. Results of the PPML regression for Tajikistan (supplemented
variable: cost to export)

57
 Table 11. Comparative illustration of untapped trade potential (in million
USD)

Tajikistan Kyrgyzstan
Uzbekistan -349.74 China -135.6
India -78.452 Uzbekistan* -110.31
Azerbaijan -48.322 USA -56.529
UK -42.011 India -49.213
Czech Republic -35.432 Germany -47.995
Germany -29.865 UK -45.152
USA -28.351 Turkmenistan -34.341
Israel -28.236 France -31.953
Japan -23.013 Tajikistan -23.635
Estonia -21.662 Azerbaijan -22.727
France -19.835 Italy -22.548
Netherlands -19.255 UAE -21.807
Romania -18.871 Netherlands* -19.628
Belgium -18.172 Lithuania -19.299
Singapore -17.635 Switzerland -19.247
Vietnam -13.872 Japan* -17.033
Ukraine -13.693 Thailand -14.351
Spain -11.946 Estonia -14.281
Belarus -10.942 Spain -13.353
Georgia -9.4688 Mexico -11.487
Poland -8.9119 Australia -8.9256
Canada -8.3819 Latvia -6.0958
Bulgaria -7.5254 Malaysia -5.464
Korea -7.2817 Pakistan -5.2869
Armenia -7.1338 Israel -4.0557
Italy -6.3642 Denmark -3.8143
Austria -5.1925 Austria -2.1481
Norway -5.1127 Czech Republic -2.0073
Kyrgyzstan -4.9283 Ireland -1.8207
* stands for sudden increase in trade potential

58