Gravity Model by Panel Data Approach: An Empirical Application with Implications for

the ASEAN Free Trade Area

Author(s): Nguyen Trung Kien
Source: ASEAN Economic Bulletin , December 2009, Vol. 26, No. 3 (December 2009), pp.
266-277
Published by: ISEAS - Yusof Ishak Institute

Stable URL: https://www.jstor.org/stable/41317069

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ASEAN Economic Bulletin Vol. 26, No. 3 (2009), pp. 266-77 ISSN 0217-4472 print / ISSN 1793-2831 electronic

DOI: 10.1355/ae26-3c

Gravity Model by Panel Data

Approach
An Empirical Application with Implications for
the ASEAN Free Trade Area

Nguyen Trung Kien

This paper examines the determinants of export flows of countries in the ASEAN Free Trade
Area (AFTA) through estimations of panel data using a gravity model. In particular ; the paper
employs the Hausman-Taylor (HT) estimation for a country panel data of thirty-nine countries
during the period 1988-2002 based on a two-way error component form of the gravity model.
The estimations show that export flows increased proportionately with GDP ; and that the
formation of AFTA has resulted in significant trade creation among its members. Finally , the
paper suggests that trade facilitation policy can play an important role in setting the stage for
AFTA's transition to a Free Trade Area.

Keywords: AFTA, gravity models, panel data, trade.

I. Introduction the interdependent context with other free trade

areas in the world. We are particularly interested
Whether the formation of ASEAN1 Free Trade
in examining whether AFTA has made a
Area (AFTA) has intensified intra-regional trade
significant difference in export performance of its
in Southeast Asian region remains a controversial
member countries compared to non-member
issue in the literature even though AFTA has been
countries.
in place for a decade since 1993. Some studies In recent years, there has been renewed interest
argue that intra-regional trade in ASEAN was in using gravity models to estimate the
strengthened in the 1990s (see Elliott and Ikemoto,
determinants of trade flows, especially in the
2004). These inferences arguments have not been context of regional trade groupings. Typical
consistent with those of studies such as Endoh
examples of applying the gravity model to
(2000) and Tran V.T. (2002). The purpose of investigate
this trade flows in the selected regional
paper is to inform this debate by examining the trade arrangements, which include AFTA, have
determinants of trade flows of AFTA members in been addressed by Endoh (2000) and Elliott and

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Ikemoto (2004). These studies provide estimations patterns of bilateral trade flows among the
using a cross-sectional approach. Few attempts European countries. In this model exports from
have so far adopted a panel data approach (see one country to another are explained by their
Cheng and Wall, 1999 and Martinez-Zarzoso and economic size (measured by GNP or GDP) and the
Nowak-Lehmann 2003). In this paper, we geographical distance between them. Since then,
the gravity model has been widely used and
estimate the gravity model by the panel data. Our
model is related to several recent papers. Endohincreasingly improved in empirical studies of
(2000) employed the gravity model with a international trade. Specifically, a population
selection of institutional dummy variables to variable was introduced to account for negative
examine the features of trade relations in the effects on trade flows (Endoh 1999, 2000). A per
Asia-Pacific region through cross-sectioncapita
data income variable was also employed to
provide
analysis. However, the roles of heterogeneity in a good proxy for the level of economic
spatial and time effects which can explain trade
development which can have a positive effect on
flows are neglected. Our two-way error international trade (Frankel, Stein and Wei 1995,
and Elliott and Ikemoto 2004). It should be noted
component model addresses these heterogeneous
effects. On the other hand, Elliott and Ikemoto that several kinds of dummy variables have been
(2004), using the modified gravity model, added into the gravity models to account for
investigated AFTA intra- and extra-regional bias specific factors, such as geographical, cultural,
in bilateral trade flows for several distinct time and institutional factors, that can support or hinder
periods, but they do not explicitly mention bilateral
the flows of goods.
role of exchange rate on trade flows. Therefore, While gravity models used in empirical
we add both exchange rates and common applications are known for their strong fit to the
language as factors affecting transaction costs of data, it is only in recent decades that their
trade over a long continuous period. predictive ability have been justified by many
Based on this two-way error component form oftheoretical studies of the model. Since Anderson's
the gravity model, we employ the Hausman-Taylor(1979) derivation of a reduced-form gravity
estimation for a panel data of export flows among equation from a general equilibrium model
thirty-nine countries over the period 1988-2002. incorporating the properties of expenditure
Then, we provide different estimations in varioussystems, a number of other studies have provided
contexts in which AFTA is interdependent withtheoretical justifications for the gravity model. For
other free trade areas. Furthermore, the context example, Helpman and Krugman (1985) derived a
which incorporates free trade area impactsversion of the gravity equation from a model that
provides us with insights on the kinds of effects consisted of sectors producing homogeneous
export flows may be influenced by AFTA. products with constant returns and those
The paper is organized as follows. Section IIproducing differentiated products with increasing
reviews gravity models of international trade andreturns. Bergstrand (1985, 1989) has developed
develops an empirical model. The estimation microeconomic foundations of the gravity
methods are discussed in section III. The results
equation under alternative assumptions. Lately,
Deardoff (1998) has shown that the gravity
are presented and discussed in section IV. Section
V presents conclusions. equation can also be derived from extreme cases
of the Heckscher-Ohlin model: one with identical,
homothetic preferences and frictionless trade, and
II. Gravity Models of International Trade the other with impeded trade when every country
produces and exports different goods.
II. 1 Gravity Models
It is now widely acknowledged in the empirical
trade literature that the gravity equation can
The gravity model was first used by Tinbergen
(1962) and Poyhonen (1963) to examine the provide a useful multivariate approach for

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assessing the impacts of regional trade agreements However, it is important to note that
on the level and direction of bilateral trade flows. heterogeneous factors may influence bilateral
Illustrations of its application to the analysis of trade. An exporting country would export different
preferential trade liberalization were highlighted amounts of a certain good to two countries, even if
by Aitken (1973) and Endoh (1999, 2000), among GDP of these two countries are identical and they
others. Aitken (1973) first included a dummy have the same distance from the exporter.
variable showing intra-regional trade to capture Therefore, the cross-section OLS estimations are
trade creation between members. Later, other likely to suffer from heterogeneous bias because
studies tried to add a second dummy variable to they explicitly fail to consider heterogeneous
illustrate extra regional trade effect with non- structural factors in errors.
members. Recently, Endoh (1999) incorporated Taking into account of unobserved
three dummy variables in order to offer a simple heterogeneous factors in errors, an econometric
and clear distinction between trade creation and specification of the gravity model in our paper is a
trade diversion. The paper follows his institutionaltwo-way error component model as follows:
dummy treatment; i.e. the first dummy capturing
trade creation, the second capturing import tradelog XtJI = Д) + dij + в, + ßi logy,, + ßi log Yj,
diversion, and the third to capture export trade + ^ log Dij + ß4 log Nu + ß5 log Nj,
diversion.
+ ß6 log FXij, + ßjLANij + £ ßskFTAmk

II. 2 Specification of Empirical Model + £ ß9kimportFTA(ijk)i

Empirical studies have shown that exports,
imports or even total trade can be suitable as the + f ßl0kexportFTAmi + log щ, (2)
dependent variable for examining the determinants
of trade flows of AFTA members. However, where /, j denote the exporter, the importer
respectively, t denotes time and к denotes the
exports and imports are more appropriate variables
for investigating whether AFTA has producednumber of free trade areas. The explanatory
variables are defined as:
trade creation and/or trade diversion because tariff
reduction schemes can promote intra-regional
trade. Considering the proxies for institutional Xijt denotes the value of export from a country i
dummy treatment, export variable is selected for to a country j at time t.
this study. Y it, Yjt denote the GDP of country /, j at time t,
We will now look at the issue of econometric respectively.
specification more closely. In most of the previous Dij denotes the geographic distance between
empirical studies based on cross section estimation capitals of two countries.
techniques, exports from a country i to a country jNit, N jt denote the population of country /, j at
(X¡j) are specified by the typical gravity equation time t, respectively.
for a given year as follows: FXijt denotes the exchange rate between country
i and country j at time t.
log X¡j = ßo + ß' log У, + ßi log Y j LANij is a dummy variable which is unity if the
+ ßi log Dii + !°g Щ (1) two countries speak the same official
language.
where Y¡ (Yj) indicates the GDP of theFTAijk
exporter
is a dummy variable which is unity if
both countries i and j belong to Free Trade
(importer), Dij measures the geographic distance
between the two countries' capital cities.AreaThe
к at time i, and 0 otherwise.
disturbance term log (щ) is assumed to be importFTAijk
iid with similarly is a dummy variable
zero mean E('og(u¡j)) = 0 and a constant variance.
which is unity if only the import country j

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 belongs to Free Trade Area к at time t , and 0 demand are expected. Coefficient on Д, would be
otherwise. expected to be negative, given that greater
ex portFTAijk likewise is a dummy variable distance increase transportation costs.
which is unity if only the export country i Next, the effect of N¡ and Nj could be positive or
belongs to Free Trade Area к at time r, and 0 negative depending on which is dominant in its
otherwise. absorption effect or economies of scale. A large
ß о is an unknown constant. population may certainly indicate a big domestic
Oty is individual effects which imply direction of market and large resource endowment, so the
export effects from country / to country j. larger absorption effect of this domestic market
6t is time-specific effects. may translate to less reliance on international trade
uijt is the log normally distributed idiosyncratic transactions. In this case, a negative sign would be
error term, where E('og(uijt)) = 0. justified. On the other hand, a large domestic
market allows the advantages of economies of
Our econometric specification in (2) is different scales to be fully exploited. It then follows that
from the previous empirical models by Endoh opportunities for trade with foreign partners in a
(2000), Elliott and Ikemoto (2004) in two respects. wide variety of goods will increase, and the
First of all, we took into account the unobserved expected sign of this coefficient would be positive.
heterogeneous factors in errors, namely specific The coefficient of FX¡j is predicted to possess a
direction of export effects a¡j and specific time positive sign since depreciation in country i will
effects 6t in the econometric model. The stimulate export flows from country i to country j.
specification built in this way allows us to deal The cultural distance measured by a dummy LAN¡j
with both spatial and time dimension. Whereas the would be expected to be positive because two
time dimension makes it possible to monitorcountries which speak the same official language
common business cycle or globalization trend over will have an opportunity to execute a transaction
our whole period, the spatial dimension has its smoothly and quickly.
ability to capture time invariant direction of export The Free Trade Area dummy variable is
effects. Therefore, our panel data approach leadsincluded to capture the intra-regional trade
us to a totally different model during this exercise
creation. If a coefficient on this dummy is positive
in econometric specification. As we can see, and statistically significant, it can show that the
Matyas (1997) and Egger (2000) strongly support members of the free trade area have traded with
the two-way error component model. each other more than the hypothetical level
Secondly, we added two new explanatorypredicted by basic explanatory variables. The
variables to the model. The first variable is a dummy import-FTA reflects any trade diversion
common language dummy. We are interested in
occurring as a result of changes in the import
language since this factor plays a role as culturalstructure of the free trade area. It takes account
distance. When two countries speak the same into the import trade diversion defined by В alassa
language, it makes communication easy and (1967). If a coefficient on this dummy variable is
reduce transaction costs between them. Therefore, negative and statistically significant, it can be
language proximity can promote bilateral trade. argued that the members of the free trade area
The other variable is the impact of exchange have rate diverted their importing activities from non-
which can be easily estimated in the panelmembers data trading countries to member countries.
approach. Finally, the dummy export-FTA characterizes the
The postulated effects of the explanatory extra-regional bias of the free trade area to the rest
variables on the dependent variables (trade flows) of world or the export trade diversion defined
is as follows. Y¡ and Yj would have positive by Endoh (1999). A negative and statistically
coefficients, since the positive correlations significant coefficient on the export-FTA variable
between GDP and export supply as well as import indicates that integration has made a member

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country to prefer exporting to other members inconsistent estimators since it neglects possible
rather than non-members. correlation between unobserved effects in errors
and the explanatory variables. A technique that can

III. Estimation Methods

utilize this advantage of REM and correct a
plausible correlation of the heterogeneous effects
The standard OLS estimator does not deal with the in errors with the explanatory variables will be a
heterogeneous issue of time and space involved in good solution. Hausman and Taylor's estimator
the panel data analysis. A proper estimation (1981) suggests a way to solve this issue, provided
method should take both direction of export that a subset of the explanatory variables is
effects ty and time effects 0, into consideration. correlated with the unobserved individual effects
Directions of export effects allow each direction of (Baltagi 2001; and Greene 2003).
export to have its own effects for unobserved Employing the Hausman and Taylor (henceforth
time-invariant historical, cultural and diplomatic HT) instrumental variable estimation technique
influences. It is clear that showing direction of requires us to clarify endogenous and exogenous
export from country i to country j is totally variables in our model.3 We assume that Yh Yj
different from aß. These unobserved effects might correlate with unobserved direction of export
be correlated with some of the explanatory effects a¡j while LAN^ has the same endogenous
variables. On the other hand, time-specific effects property. Other remaining variables are
imply unrelated influences on direction of export exogenous, uncorrected with a¡j. Furthermore, we
such as potential trends or business cycles. Since identify instrumental variables as follows: Yh Yj
most of these influences are usually unobservable, are instrumented by their deviations from
it is appropriate to include these effects in the individual means, while LAN¡j is instrumented by
econometric model in order to control them. the individual average of the exogenous time-
To take into account heterogeneous effects in varying variables (Nh Np FX¡j). All exogenous
errors in our two-way error component model, variables serve as their own instruments.
there are basically two available models: a fixed
effects model (hereafter, referred to FEM) and a
IV. The Results
random effects model (referred to REM). We use
In order to provide empirical results, we
the Hausman test to examine whether the
specification of REM is correct. investigate a data set covering thirty-nine
It is important to note that we select the of which twenty-six are members of four
countries
dynamic way2 to follow the introduction offree trade areas, namely, EU, AFTA, NAFTA and
a free
trade area, in which a set of free trade area
MERCOSUR4 for the overall fifteen-year period,
institutional dummies takes unity only for the 1988-2002. Data sources are given in Appendix.
effective years of free trade area between two We have estimated results in two contexts.
trading countries. This allows us to observe the Firstly, we estimate the gravity model (2) without
dynamic effect of the formation, expansion or any institutional dummy variables as the
contraction of the free trade area. benchmark context. Next, we estimate it in a full
We have paid particular attention to the fact that specification to measure the impacts of free trade
this model contains not only time varying areas on its export flows.
variables such as GDPs, population, exchange rate
and sets of FTA dummies, but also time invariant
IV. 1 Results in the Benchmark Context
variables namely distance and language. It is
worth noting that FEM does not allow for According to Table 1 which shows the regression
estimating these time invariant variables. On the results, we find that all estimated coefficients on
contrary, REM has the advantage of handling this the levels of GDPs and the distance show highly
kind of explanatory variables, but produces significant at 1 per cent level with the expected

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 TABLE 1
Coeficient Estimates in the Benchmark Context

Dependent variable: export Pooled OLS FEM REM HT

An exporter's GDP 1.051 1.322 1.140 1.318
(143.46)** (36.53)** (58.21)** (40.70)**
An importer's GDP 0.934 1.111 1 .065 1.110
(128.06)** (84.61)** (92.29)** (86.26)**
Geographic distance -0.907 - -0.889 -0.790
(94.43)** (27.88)** (13.25)**
An exporter's population -0.126 -0.026 -0.114 -0.135
(18.79)** (0.79) (6.27)** (5.17)**
An importer's population -0.085 -0.270 -0.222 -0.255
(12.57)** (21.69)** (20.30)** (21.06)**
Exchange rate 0.022 0.018 0.019 0.018
(10.38)** (8.14)** (8.82)** (8.24)**
Language 1.124 - 1.089 3.054
(34.97)** (10.12)** (2.21)*
Constant -10.879 -23.857 -13.312 -16.851
(71.61) ** (53.98) ** (33.72) ** (22.59) **
Observations 21901 21901 21901 21901
Adjusted /^-squared 0.75
F test (1493, 20400) 49.49
Hausman Test 127.59
Hausman Test* 129.45

Notes: Absolute value of t statistics is reported in parenthese

* denotes significant at 5 per cent;
** denotes significant at 1 per cent.
All individual effects are not reported.

Martinez-Zarzoso It
sign in all estimation methods. and Nowak-Lehmann
is remarkable (2003)
that the coefficients on GDPs show the income
who argued that controlling the heterogeneous
effects in errors is likely to increase the estimates
elasticities of trade with respect to an exporter's
of GDPs. One possible reason for this is that the
and an importer's income. At first glance at the
pooled OLS result, 1 per cent increase ingrowth an in volume of exports is partly attributed to
exporter's GDP raises the volume of exportsunobserved
on heterogeneous factors in errors that
average by about 1.05 per cent while tradeseem is to be neglected in the pooled OLS.
inelastic with respect to an importer's GDP. Then,The coefficient on geographic distance shows
allowing for direction of export effects in FEM,that distance negatively affects export flows.
REM and HT greatly raise these estimated incomeControlling for heterogeneous effects considerably
elasticities of trade. lowers this coefficient value except for FEM result
The result shows that the income elasticities of although the effect of distance is still highly
trade are entirely different from Elliott and significant.
Ikemoto (2004) but are consistent with the As a result, we reconsidered the specification
previous studies by Cheng and Wall (2002), andtest of the estimation methods. We performed the

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F-test on the null hypothesis of the same direction dummy presents an expected sign but is
of export effects cç, across countries and the same statistically insignificant.
time effect Qt over time. The F-statistics in Table 1 In general, it is clear that free trade area
shows that we cannot accept the null hypothesis of regime has not brought the same impacts to every
equality of heterogeneous effects in errors. The regional trade grouping. While it has similar
Hausman test gives us more insights. A high value effects on MERCOSUR and NAFTA, it has
of the chi-squared statistic allows us to reject the caused totally opposite effects on AFTA and EU.
null hypothesis that explanatory variables and But in another aspect, we realize that trade
unobserved heterogeneity are uncorrected. This creation has appeared in all free trade areas
leads us to prefer FEM although time-invariant except for the EU. However, only the EU has
variables are absorbed into the fixed effects. resulted in the import trade diversion while all
Importantly, we use the Hausman test on thefreenulltrade areas excluding AFTA have yielded the
hypothesis as some explanatory variables export
are trade diversion.
The results show that trade creation in AFTA is
uncorrelated with heterogeneous effects in errors.
similar
Rejecting the null hypothesis further convinces us to that of Elliott and Ikemoto (2004) but
that this HT estimation is more appropriate than
differs from the previous studies such as Endoh
others in order to satisfy the properties of(2000)
the and Tran V.T. (2002). It is more important
explanatory variables in our model. to note that we have entered all free trade area
dummies in a dynamic way. This approach
The coefficients on population reflecting
market size are negative and highly significant at
permitted us to offer a new finding that AFTA has
the HT result. Regarding the exchange rate, its
significantly affected export flows in the years
after its formation. The HT result shows that the
coefficient is generally positive and highly
significant. The language dummy is also intra-regional trade for AFTA increased to a higher
significant at 5 per cent with a positive sign at level of 0.626, implying that AFTA members have
the HT result. This result confirms our traded with each other more than the level
assumption that the language factor canpredicted correlatein the benchmark context.
with other unobserved time-invariant effects such Nevertheless, it can be seen that the magnitude
as cultural and historical factors. This point also of trade diversion effects involves two aspects. A
highlights that two countries sharing common positive coefficient on the import AFTA dummy
linguistic, cultural or historical features tend to suggests that AFTA members have not transferred
trade more than they would otherwise. their import transaction from non-member
countries to member ones. It means that there has

IV 2 Results in the FTA Context

been no import trade diversion over the period of
ten effective years. One possible interpretation is
The estimates of GDPs at the HT result at Table 2 that the dynamic network of domestic production
together with foreign investment projects in AFTA
further strengthen our finding that trade increases
more than proportional with the GDPs of the countries have caused these countries to prefer
exporter and importer. A close look at the HTimporting from non-members outside the region.
result reveals that the absolute estimate on Another alternative explanation may be that
electrical and electronics (E&E) products
distance is larger than the one in the benchmark
context. This point can infer that distance represent
becomes a very large share of traded products
a more important impediment to export flows
among the ASEAN member countries during this
period,
under free trade area impacts. One explanation forand that intra-industry trade and intra-
this may be that the impacts of free tradeaffiliate
areas trade is the largest in this sub-sector for
have caused trading countries to prefer thedoing
region. Given that E&E products already face
transactions with their closer ones. It is
low or zero tariffs, (especially in the free trade
noteworthy that the coefficient of thezones where the MNCs operate), the reduction in
language

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 TABLE 2
Coefficient Estimates in the FTA Context

Dependent variable: export Pooled OLS FEM REM HT

An exporter's GDP 1.202 1.090 1.117 1.047
(156.92)** (29.20)** (63.56)** (40.50)**
An importer's GDP 1.008 1.118 1.064 1.088
(132.80)** (86.31)** (96.29)** (89.27)**
Geographic distance -0.858 - -0.936 -0.950
(77.95)** (33.41)** (26.55)**
An exporter's population -0.223 -0.030 -0.139 -0.104
(33.54)** (0.93) (8.50)** (5.17)**
An importeris population -0.141 -0.280 -0.222 -0.245
(21.00)** (22.91)** (21.18)** (21.88)**
Exchange rate 0.027 0.004 0.010 0.008
(13.81)** (1.88) (4.25)** (3.75)**
Language 1.064 - 1.047 0.458
(35.08)** (11.37)** (1.22)
AFTA 2.225 0.529 0.666 0.626
(29.50)** (8.49)** (10.81)** (10.24)**
Import AFTA 0.681 0.169 0.223 0.204
(21.45)** (6.42)** (8.56)** (7.90)**
Export AFTA 0.994 0.562 0.597 0.593
(31.35)** (20.76)** (22.84)** (22.76)**
EU -0.456 -0.053 -0.187 -0.156
(11.93)** (1.07) (4.05)** (3.29)**
Import EU -0.200 -0.067 -0.129 -0.119
(8.59)** (1.91) (4.09)** (3.66)**
Export EU -0.571 0.020 -0.086 -0.048
(24.66)** (0.59) (2.73)** (1.48)
MERCOSUR 1.085 0.453 0.480 0.474
(8.77)** (4.93)** (5.22)** (5.20)**
Import MERCOSUR -0.255 0.556 0.486 0.508
(6.39)** (18.42)** (16.23)** (17.10)**
Export MERCOSUR -0.853 -0.061 -0.095 -0.087
(21.05)** (1.98)* (3.10)** (2.87)**
NAFTA 0.073 0.292 0.279 0.287
(0.45) (2.22)* (2.13)* (2.21)*
Import NAFTA -0.0001 0.143 0.126 0.134
(0.00) (4.33)** (3.83)** (4.12)**
Export NAFTA -0.982 -0.160 -0.199 -0.181
(22.83)** (4.82)** (6.04)** (5.53)**
Constant -13.335 -21.084 -12.473 -11.801
(86.21)** (46.17)** (35.41)** (24.80)**
Observations 21901 21901 21901 21901
Adjusted Ä-squared 0.79
F-test (1493,20388) 41.52
HausmanTest 3331.54
HausmanTest* 130.73

Notes: Absolute value of t statistics is reported in parenth

* denotes significant at 5 per cent;
** denotes significant at 1 per cent.
All individual effects are not reported.

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the Common Effective Preferential Tariff (CEPT) trade arrangements empirically analysed, only
would not have much impact on trade in this NAFTA and MERCOSUR have the same patterns
commodity group. The imports are based on the of trade effects, while AFTA is completely
comparative advantage that each member country opposite to the EU in trade effects. We also find
has for producing that segment in the production evidence of only trade creation in AFTA, and
of E&E products. evidence of only trade diversion in the EU. The
On the other hand, we find that AFTA has not reasons for this require further study and
given rise to export trade diversion as the investigation.
coefficient of AFTA dummy is positive and Finally, distance has a negative impact on
statistically significant. A plausible explanation for export flows and the formation of free trade area
this finding is that export-oriented strategies have seems to strengthen this impact. One remarkable
been an engine of economic growth for these fact is that transport costs still take a larger share
countries for many years. Moreover, the in transaction costs when compared with those of
characteristics of production and consumption in tariffs, and that they represent the main
all member countries may have led them to impediment to trade flows (World Bank 2002). It
persistently search for non-members as their is widely recognized, however, that transport
export destinations. costs have declined considerably in the past fifty
On the whole, test statistics for the significance years, especially in the last decade as global
of the heterogeneous effects in errors in the economic integration has rapidly progressed
models affirms the study's prior assumption on (World Bank 2004). This implies improved
this issue. Furthermore, the results of the Hausman efficiency in the administration, procedures, and
test on the uncorrelation between explanatory logistics at ports and customs. Hence, in order to
variables and heterogeneous effects in errors are further promote export flows, an improvement in
rejected further. This provides convincing trade facilitation becomes one of the most
evidence of the appropriateness of the HT suitable policies in the area of transport. Without
estimators. Therefore, this overall argument such improvement, free trade area regime might
proves the advantage of the study's preferred fail to achieve the targets of promoting intra-
estimation method over the conventional OLS in regional trade.
the empirical specification of the gravity model.

IV .4 Policy Implications
IV.3 Discussion
The empirical findings show that AFTA members
are estimated to have traded about 87 per cent
The findings lead to the following key inferences.
Firstly, the result for the language variablemore
is with its members. At the same time, these
members seem to have fostered extra-regional
mixed. The coefficient has the expected positive
trade with non-members at 1.2 times more than
sign in all estimations but is not statistically
significant in the HT estimation. Thus, there is would expect based on the benchmark
one
weak statistical support for the hypothesis thatcontext.5 In fact, while AFTA trade regimes have
language differences are important in explainingenhanced intra-regional trade, they have also
trade flows. This finding is somehow similar to reinforced
the the need for AFTA members to trade
effects of intra-industry trade in the trade theorywith
of non-members outside the region. These
monopolistic competition (Krugman 1979; findings reflect the current regional production
Helpman and Krugman 1985). networks in ASEAN countries as well as the effect
of CEPT schemes on the flows of goods. The
Secondly, it is interesting to note that all free
trade areas do not have identical patterns in trade
proliferation of several free trade areas involving
ASEAN and its members in the coming years is
creation and trade diversion. Of the four regional

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expected to influence the directions of trade within the gravity framework and estimated using
between AFTA members and non-members. Hausman-Talyor method fits the data remarkably
Consequently, export flows would increaseand its estimated results are highly significant.
through trade facilitation efforts, and this has The results suggest that GDP, population, and
another policy implication: It is necessary tolanguage among other factors can explain export
designate and to implement policy on trade flows. Export flows among countries are found to
increase more than proportionately with GDPs.
facilitation in trading countries; otherwise, AFTA
regime may fail to achieve the targets of This point reconfirms the result obtained
previously by including the heterogeneous effects
promoting intra-regional trade and cannot result in
trade diversion. AFTA members are reasonable in errors but differs from the results reported by
when promoting trade facilitation through Elliott
the and Ikemoto (2004). In addition, it seems
integration and modernization of the customs
reasonable to conclude that trade might be higher
among countries in which the same language,
processes. It is known that ASEAN has achieved
rather than different languages, is used although
significant progress in adopting best practices and
provision of the Revised Kyoto Convention with the relationship is statistically not very strong.
a view to simplify and harmonize customs Perhaps the most important finding of the study is
that AFTA has only produced trade creation
procedures and practices (ASEAN Annual Report
2003-2004). Overall, this implication can guide
among its members. This finding is inconsistent
policy-makers to devise trade facilitation
with a number of previous studies but strengthens
the finding of Elliott and Ikemoto (2004). More
initiatives which serve to intensify the flows of
goods. This also promotes the building of the importantly, the dynamic way of following free
ASEAN Economic Community. trade area effects allows us to reach another
finding - that the impact of AFTA immediately
appeared in export flows in the subsequent years
V. Conclusions
of 1993. Finally, we find that geographic distance
This paper has investigated the determinantsmight
of impede trade more strongly in the context of
trade flows of AFTA member countries with an free trade areas. This result suggests the importance
of improving trade facilities, which could
emphasis on the impact of free trade area relative
to other factors. The trade flow model derived strengthen the targets of free trade area regime.

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Appendix Data Sources

The volume of export (in FOB terms, U.S. dollars) are derived from The Direction of Trade (DoT) CD-ROM 2003 by
IMF, Population and real GDP (in constant 1995 U.S. dollars) are from the World Development Indicators 2004 report
published by World Bank. The foreign exchange rata are obtained and converted from the International Financial
Statistics Database 2003 report published by IMF. In addition, the geographic distance data between two capital cities
were downloaded from this website <http://www.indo.com/distance> and expressed in kilometres. Information about
the official language of countries is extracted from Encyclopedia Britannica.
Country coverage: 13 EU countries (Austria, Denmark, Finland, France, Germany, Greece, Ireland, Italy,
Netherlands, Portugal, Spain, Sweden and U.K.), 6 AFTA countries, 3 NAFTA countries (United States, Canada and
Mexico) and 4 MERCOSUR countries (Argentina, Brazil, Paraguay and Uruguay). The remaining 13 are Australia,
New Zealand, Japan, Korea, China, Hong Kong, India, Pakistan, Bangladesh, Turkey, Norway, Switzerland, and
Chile.

NOTES

The author would like to thank Kenzo Abe, Prema-chandra Athukorala and Yoshizo Hashimoto for their v
suggestions and opinions. I also wish to thank the anonymous referees for their useful comments and sugg
However, I am solely responsible for any errors that remain.
1 . The Association of South East Asian Nations (ASEAN) formed the ASEAN Free Trade Area (AFTA) sinc
This study only covers six members including Indonesia, Malaysia, the Philippines, Singapore, Thailan
Vietnam. The other members such as Brunei, Myanmar, Lao PDR and Cambodia do not have sufficient d
2. Applying the dynamic ways to follow FTA introduction allows these variables to take a value of on
overall observed period only when FTAs occur. Note that AFTA has been effective since 1993, NAFTA start
1994, and that MERCOSUR in 1995.
3. This model satisfies the identification requirement since the number of exogenous time- varying variables is
bigger than the number of endogenous time-invariant ones.
4. Specific names for the set of institutional dummy variables in each corresponding free trade areas are denoted as
follows: AFTA, import-AFTA, export-AFTA; EU, import-EU, export-EU; NAFTA, import-NAFTA, export-
NAFTA and MERCOSUR, import-MERCOSUR and export-MERCOSUR.
5. These figures are calculated by taking the antilog of the corresponding estimated coefficients at the HT and
subtracting 1, as the dependent variable is in log form. Note that the magnitude of extra-regional trade comprise
of export trade diversion and import trade diversion.

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