Trade Potentials in Gravity Panel Data Models
Topics in Economic Analysis & Policy, Vol. 5, No. 1, Article 20
26 Pages Posted: 26 Feb 2004
The paper shows how - using as an example the trade flows between eleven European countries and 31 OECD 'reporting' countries - the result of a gravity model, in terms of potential trade, changes substantially when country heterogeneity and dynamics are taken into account.
Comparing the in-sample trade potential index derived from various estimators yields three different results: (a) the average trade potential index poorly represents the distribution of yearly trade potentials; (b) the index converges towards the demarcation value corresponding to the equality between observed and predicted trade flows when country heterogeneity and dynamics are taken into account; (c) the sign of its yearly average is not the right statistic with which to determine the (in)existence of unrealized trade potentials.
Finally, the index derived from a dynamic specification with multilateral fixed-effects is better able to reflect the role played by the time-variant country-specific unobservable element associated with the possible presence of positive or negative trade potentials.
Keywords: International bilateral trade, gravity model, trade potentials, dynamic panel data
JEL Classification: C13, C14, F10, F43
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