Regional Integration Agreements: Trade Flows and Economic Crisis: A Static and

Dynamic Gravity Model

 RTAs are defined as reciprocal trade agreements between two or more partners. They include free
trade agreements and customs unions.
 RTAs strengthening is a crucial component of the contemporary global economy (these are
beneficial in trade, FDI, growth, etc. and are a stabilising factor in international relations, to reduce
barriers to the circulation of goods, services, capital, labour, etc).
 There are over 546 RTAs which have been notified to the WTO where nearly 354 are active.
 There are theoretical and empirical studies conducted on RTAs. Of which Gravity Model is
successful and used in different types of flows (migration, buyer’s flows at shopping centres, patient
flow in hospitals and inter and intra national trade).
 Gravity Model is preferred as it analyses the importance of the pull factors for trade and FDI. It uses
static and dynamic panel data to measure impact of RTAs on export flows between regions,
determine the relevance of other determinants of bilateral exports such as GDP, population,
geographical proximities and cultural similarities and assess the impact of the global economic crisis
on the export flows and regional groupings.
(The RTAs examined here are the EU-15, NAFTA, ASEAN, Mercosur, the Maghreb area and the
EUROMED).
In the Gravity Model there are two types of equation to assess the impact of RTAs. They are:
 The Static Gravity equation.
In EXPijt = 𝜷𝟎 +𝜷𝟏𝑰𝒏𝑮𝑫𝑷𝒊𝒕 + 𝜷𝟐𝑰𝒏𝑮𝑫𝑷𝒋𝒕 + 𝜷𝟑𝑰𝒏𝑷𝑶𝑷𝒊𝒕 + 𝜷𝟒𝑰𝒏𝑷𝑶𝑷𝒋𝒕 + 𝜷𝟓𝑰𝒏𝑫𝑰𝑭𝑮𝑫𝑷𝒊𝒋𝒕 + 𝜷𝟔𝑰𝒏𝑺𝑰𝑴𝑳𝒊𝒋𝒕 +
𝜷𝟕𝑰𝒏𝑹𝑬𝑹𝒊𝒋𝒕 + 𝜷𝟖𝑰𝒏𝑫𝑰𝑺𝑻𝒊𝒋 + 𝜷𝟗𝑰𝒏𝑳𝑨𝑵𝑮𝒊𝒋 + 𝜷𝟏𝟎𝑩𝑶𝑹𝑫𝒊𝒋 + 𝜷𝟏𝟏𝑪𝑶𝑳𝒊𝒋 + 𝜷𝟏𝟐𝑪𝑹𝑰𝑺𝑰𝑺𝒊𝒋𝒕 + 𝜮𝜸𝒌 𝑹𝑻𝑨. 𝑰𝑵𝑻𝑹𝑨𝒊𝒋𝒕 +
𝜮𝜹𝒌 𝑹𝑻𝑨. 𝑬𝑿𝑷𝒊𝒋𝒕 + σ 𝝆𝒌 𝑹𝑻𝑨. 𝑰𝑴𝑷𝒊𝒋𝒕 + 𝑼𝒊𝒋𝒕, … … … … … … … … … . . 𝟏
(where i and j represent exporting and importing countries in time period t, Expijt represents nominal export from nation i to j, DISTijt is the
distance between nation i to nation j (measured in kilometers), POPit represents the existing population of the exporting country for the year
t, POPjt is the population of the importing nations, GDPit is the GDP of the exporting country, GDPjt is the GDP for the importing countries,
RERijt is the real exchange rate among exporters and importers over time, INFit is the inflation of exporting countries, INFjt is the inflation
of importing countries, SIMLijt is an indicator of the similarity of the size of the GDP of the countries, DIFGDPijt is the absolute value of the
difference in GDP of the countries, LANGij is represented by a dummy for common language partners).

 The Dynamic Gravity equation.

In EXPijt = 𝜷𝟎 +𝝀𝑰𝒏𝑬𝑿𝑷𝒊𝒋, 𝒕 − 𝟏 + 𝜷𝟏𝑰𝒏𝑮𝑫𝑷𝒊𝒕 + 𝜷𝟐𝑰𝒏𝑮𝑫𝑷𝒋𝒕 + 𝜷𝟑𝑰𝒏𝑷𝑶𝑷𝒊𝒕 + 𝜷𝟒𝑰𝒏𝑷𝑶𝑷𝒋𝒕 + 𝜷𝟓𝑰𝒏𝑫𝑰𝑭𝑮𝑫𝑷𝒊𝒋𝒕 +
𝜷𝟔𝑰𝒏𝑺𝑰𝑴𝑳𝒊𝒋𝒕 + 𝜷𝟕𝑰𝒏𝑹𝑬𝑹𝒊𝒋𝒕 + 𝜷𝟖𝑰𝒏𝑫𝑰𝑺𝑻𝒊𝒋 + 𝜷𝟗𝑰𝒏𝑳𝑨𝑵𝑮𝒊𝒋 + 𝜷𝟏𝟎𝑩𝑶𝑹𝑫𝒊𝒋 + 𝜷𝟏𝟏𝑪𝑶𝑳𝒊𝒋 + 𝜷𝟏𝟐𝑪𝑹𝑰𝑺𝑰𝑺𝒊𝒋𝒕 +
𝜮𝜸𝒌 𝑹𝑻𝑨. 𝑰𝑵𝑻𝑹𝑨𝒊𝒋𝒕 + 𝜮𝜹𝒌 𝑹𝑻𝑨. 𝑬𝑿𝑷𝒊𝒋𝒕 + σ 𝝆𝒌 𝑹𝑻𝑨. 𝑰𝑴𝑷𝒊𝒋𝒕 + 𝑼𝒊𝒋𝒕, … … … … … … … … … . . 𝟐
(here 𝜆 is the adjustment coefficient in this model).

The analysis of the effect of creation and diversion trade:

In EXPij = VEij+σ𝒓 𝜸𝒓 𝑫𝒓 + σ𝒓 𝜹𝑫𝒓𝒊 + σ𝒓 𝝆𝑫𝒓𝒋…………..(3)
(Dr= (DriDrj) is a dummy variable that takes the value 1 if both countries I and j belong to the same economic bloc, zero otherwise. Dri is a
dummy value that takes the value 1 if I region is a member of region R and j belongs to the whole world. Drj is a dummy value that takes the
value 1 if j is a member of the region r and I belongs to the whole world, zero otherwise).
Results:
 The results of the Gravity Model through the equations shows the statistically significant coefficients having
hypothesized signs by using F-test for the common intercept.
 Negative values support the view that the countries are more populated, no variable gap in the per capita income,
etc.
 Positive values imply that intra-regional trade is high and the effect of the trade creation exists.
 Integration has pushed members to prefer members to non-member economies n their import activities. This
effect is called diversion of import trade, the dummies show significant evidence of import dicersion effects
indicating that trade with non-members is less than what is predicted by the model of dynamic gravity (inference
is according to the facts and figures in the article).

CONCLUSIONS:
 The examining of the export flows using these models have important applications for the policy makers in
implementing the policy to encourage the member countries to export flows, promote and develop programs to
attract more business relationships and support economic development.
 The results also show how the global economic crisis has affected the export flows.
 Improve the image of the partner countries by improving the business environment and level of services which
are essential. And that the regional dummy variables affect the gravity model of trade positively.
 However political instability maybe an obstacle to attract more export flows. Government should make a
concerted effort to reduce the negative political impact on trading partners. The Ministry of Trade and Ministry
of Industry will should develop models that are friendly to the trade policies and stimulate and support export
flows and economic growth.
Trade Effects of Regional Integration in Imperfect Competition: Evidence from the
Greater Arab Free Trade Area(GAFTA)
 Imperfect Competition is a type of market structure showing some but not all features of competitive markets.
Forms of imperfect competition include: Monopolistic competition(A situation in which many firms with slightly
different products compete).
 The GAFTA refers to the agreement concluded by 14 Arab countries to achieve Free Trade Area. It includes almost
all Arab countries, the tariffs have been removed in all those areas and the provisions of GAFTA are complemented
by several regulations concerning trade liberalization of services as well as cooperation in the field of research and
technology.
 The Gravity model and CGE(computable general equilibrium) model concludes that there is limited effects on the
trade due to GAFTA(as only direct trade effects are regarded in a perfect competition framework).
 Therefore a new model of trade theory has been developed which shows the potential gains due to imperfect
competition and provide additional insights into the quantitative impact of the GAFTA Agreement.
 As the economies of scale are significant in most GAFTA countries, which means that there is still a great potential
of intra-trade and reap benefit from a deeper regional integration resulting in larger accessible markets. And GAFTA
is more trade creating than trade diverting.

The model generated includes new developments in gravity equations as well as in supply-demand export equations.
The advantage of this model is that it simultaneously takes into account mass variables(GDPs) and trade costs, but
doesn’t include some crucial variables which are specific to the imperfect competition framework, product varieties
and scale of economies(included in supply-demand export model).
EQUATIONS:
𝑆 𝑌𝑖𝑡 + 𝑎2 𝑙𝑜𝑔𝜃𝑖 + 𝑎3𝑙𝑜𝑔𝐴𝑗𝑡 + 𝑎4𝑙𝑜𝑔𝑥 𝑆 𝑖𝑗𝑡 − 1 + 𝑎5𝑙𝑜𝑔𝑃 𝑥 𝑖𝑗𝑡 (1)
log𝑥 𝑖𝑗𝑡 = 𝑎0 + 𝑎1 𝑙𝑜𝑔
𝑃𝑖
log 𝑋 𝑑 𝑖𝑗𝑡 = 𝑏0 + 𝑏1𝑙𝑜𝑔𝑌𝑗𝑡 + 𝑏2𝑙𝑜𝑔𝑁𝑖𝑡 − 𝑏3𝑙𝑜𝑔𝐷𝑖𝑗 − 𝑏4𝑙𝑜𝑔𝑇𝑖𝑗𝑡 − 𝑏5𝑙𝑜𝑔𝐿𝑖𝑗 − 𝑏6𝑙𝑜𝑔𝐵𝑖𝑗 + 𝑏7 log − 𝑏8𝑙𝑜𝑔𝑃 𝑋 𝑖𝑗𝑡 2
𝑃𝑗𝐸𝑖𝑗
log 𝑋 𝑑 𝑖𝑗𝑡 = 𝑙𝑜𝑔𝑋 𝑠 𝑖𝑗𝑡 = 𝑙𝑜𝑔𝑋𝑖𝑗𝑡 3
𝑏8 𝑎5
log 𝑋 𝑆 𝑖𝑗𝑡 = + 𝑎5 𝑎0 + 𝑎1𝑙𝑜𝑔𝑌𝑖𝑡 + 𝑎2𝑙𝑜𝑔𝜃𝑖 + 𝑎3𝑙𝑜𝑔𝐴𝑖𝑗 + 𝑎4𝑙𝑜𝑔𝑋 𝑆 𝑖𝑗𝑡 − 1 + + 𝑏8 ൤𝑏0 + 𝑏1𝑙𝑜𝑔𝑌𝑗𝑡 + 𝑏2𝑙𝑜𝑔𝑁𝑖𝑡 − 𝑏3𝑙𝑜𝑔𝐷𝑖𝑗 −
𝑏8 𝑎5
(Equation (1) is an export supply equation, which states that exports from country i to country j at year t depend on country I’s GDP- standing for its capacity to
produce (Yit), scale of economies (𝜃𝑖) as well as expectations of suppliers with regards to the importing country j (Ajt). Export also depends on export prices (P^x
ijt), as exports are more profitable for higher process, ceteris paribus. Through this supply can be related to its past values.
Equation (2) reflects the export demand equation. It depends on country j’s GDP (Yjt), the number of varieties offered by the exporting country (Nit), the various
trade costs, proxied by distance (Dij), tariffs (Tij), the differences in languages (Lij) as well as border effects (Bij). The latter measures the specific cost of crossing
a frontier. (𝑃𝑖 /𝑃𝑗𝐸𝑖𝑗) captures the relative competitiveness of country j. indeed, if the price index in j (Pj) increases or if the exchange rate between I and j (Eij)
appreciates, country I finds more competitive power to conquer the market j. it finally includes (𝑃 𝑋 𝑖𝑗𝑡). It is expected that the higher these prices, the lower export
demand.
Equation (3) reflects the equilibrium where export supply is equal to export demand).
Further it is transformed, assumed homogenous, approximated translog to the degree of theta(𝜃), conditioned to get the maximum output subjected to constraint,
normalising the translog parameters by differentiating, and then it can estimated through the usage of Full Information Maximum Likelihood(FIML).

Results: Here the inference is drawn by calculating the values for the full country and for the restricted country samples.
(Inference drawn is from the results of the application of the equation to find out the potentiality of GAFTA)
 The implementation of GAFTA agreement has made it possible to increase significantly intra-regional trade across Arab
countries.
 Trade gains due to imperfect competition remain small and that actual trade figures hardly reach the potential trade levels.
 The market structures barely give room to gains in imperfect competition, due to the absence of product differentiation and
intra-industry trade and due to similarity of consumer tastes and production costs.
Some limitations are: Although tariffs have been removed, some GAFTA members have started new trade barriers(taxes or other
NTBs).
 Shallow integration; absence of fully fledge dispute settlement mechanism, inability to reach a detailed rules of origin scheme.
 No supra-national institutions or strong leading country to solve the problem of disputed matters. This leads to ineffective
reaping of benefits through economies of scale by producing large product varieties.
 Thus the gains from imperfect competition is not realised, and there is further room for the trade gains provided (i) reduction of
existing NTBs (ii) efforts to go towards deeper integration process. And also political cooperation and possible to control
disputes.