This paper uses a gravity model to assess ex-post regional trade agreements. The model includes 130 countries and is estimated with panel data over the period 1962–1996. The introduction of the correct number of dummy variables allows for identification of Vinerian trade creation and trade diversion effects, while the estimation method takes into account the unobservable characteristics of each pairs of trade partner countries, the endogeneity of some of the explanatory variables as well as a potential selection bias. In contrast to previous estimates, results show that regional agreements have generated a significant increase in trade between members, often at the expense of the rest of the world.
After a long period of neglect from the late 1960s to the late 1980s, the gravity trade model has acquired a second youth. First, new theoretical foundations have been proposed both with the advent of trade theories based on increasing returns to scale, in imperfectly competitive markets and firm-level product differentiation (Helpman and Krugman, 1985; Bergstrand, 1985 and Bergstrand, 1989; Baier and Bergstrand, 2001; Evenett and Keller, 2002) and, within a perfect competition setting, with product differentiation at the national level (Deardorff, 1998; Anderson and Van Wincoop, 2003). Second, the gravity model has been used extensively to study trade patterns, as for example in the case of the drastic changes following the demise of central planning. Most recently, in the estimation of models of geography and trade, the gravity model is, once again, holding center stage (Hummels, 2001, Redding and Venables, 2004, Limao and Venables, 2001 and Brun et al., 2002). In fact, the gravity model has also become a favored tool to assess the ex-post trade effects of a currency union (Glick and Rose, 2002; Rose and Van Wincoop, 2001), or the trade creating (TC) and trade diverting (TD) effects associated with regional trade agreements (RTAs) (Frankel, 1997; Soloaga and Winters, 2001). However, for reasons elaborated in this paper, previous estimates of TD and TC are likely to be unreliable.
This paper has paid particular attention to the specification and the estimation of the gravity model to correct for biases present in previous studies. The panel estimation with bilateral specific random effects was revealed to be statistically justified after correcting for the endogeneity of the income, size, infrastructure and intra-RTA trade variables. Moreover, dummies were introduced to take into account the selection rule of the sample. Arguably, these modifications lead to a better formulation of the counterfactual against which one assesses the trade performance of RTAs.
