Trade Creation and Diversion Revisited: Accounting for Model Uncertainty and Natural Trading Partner Effects

IMF WP/08/66

32 Pages Posted: 17 May 2010

See all articles by Theo S. Eicher

Theo S. Eicher

University of Washington - Department of Economics

Christian Henn

International Monetary Fund

Chris Papageorgiou

International Monetary Fund (IMF) - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: March 17, 2008

Abstract

Trade theories covering Preferential Trade Agreements (PTAs) are as diverse as the literature in search of their empirical support. To account for the model uncertainty that surrounds the validity of the competing PTA theories, we introduce Bayesian Model Averaging (BMA) to the PTA literature. BMA minimizes the sum of Type I and Type II error, the mean squared error, and generates predictive distributions with optimal predictive performance. Once model uncertainty is addressed as part of the empirical strategy, we report clear evidence of Trade Creation, Trade Diversion, and Open Bloc effects. After controlling for natural trading partner effects, Trade Creation is weaker – except for the EU. To calculate the actual effects of PTAs on trade flows we show that the analysis must be comprehensive: it must control for Trade Creation and Diversion as well as all possible PTAs. Several prominent control variables are also shown to be robustly related to Trade Creation; they relate to factor endowments and economic policy.

Keywords: Trade Creation and Trade Diversion, Preferential Trade Agreements, Bayesian Model Averaging, Country-Pair Fixed Effects

JEL Classification: F10, F15, C11

Suggested Citation

Eicher, Theo S. and Henn, Christian and Papageorgiou, Chris, Trade Creation and Diversion Revisited: Accounting for Model Uncertainty and Natural Trading Partner Effects (March 17, 2008). IMF WP/08/66. Available at SSRN: https://ssrn.com/abstract=1609675 or http://dx.doi.org/10.2139/ssrn.1609675

Theo S. Eicher (Contact Author)

University of Washington - Department of Economics ( email )

Box 353330
Seattle, WA 98195-3330
United States

Christian Henn

International Monetary Fund ( email )

700 19th St NW
Washington, DC 20431
United States

Chris Papageorgiou

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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