Gravity Model and Gross Domestic Product in Global Trade

Gravity Model

The gravity model of international trade is often used to assess the effects of trade agreements concluded by two or a group of countries. The basic idea is to add an empirical variable in the standard gravity model reflecting the impact of the trade agreements on the level and direction of trade flows from one country to another. The three key variables include the GDP of the exporting country, the GDP of the importing country, and the geographical distance between the two countries (Bergeijk and Brakman 29). The gravity equation is considered to be a strong conceptual and empirical explanation of international trade.

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The importance of the classical form of the gravity equation is in the fact that it assumes a positive dependence on the volume of the trade between the two countries’ GDP, which characterize the size of the economy and the distance between them. In their turn, the latter characterizes the cost of goods delivery from one market to another while GDP has a positive outcome on engaging foreign investments.

The distance between the importer and the exporter that is a proxy for trade barriers might have a significant negative impact on the volume of the trade. For example, not only the distance should be taken into account but also the distance value in comparison with distances to other trading partners, in other words, so-called multilateral resistance should be considered. The volume of the bilateral trade between the two countries negatively depends on the barrier trade compared to the average quantity of the trade barriers with all other trading partners or regions. The explanation of the above fact can be summarized as follows: the more difficult is the trade between the two countries, the greater the incentives created for their mutual trade.

In addition to the relative distance, an essential impact is made by the other spatial factors, in particular, the location of the checkpoints. In this case, there are two simultaneously exert opposing effects: on the one hand, the opening of additional crossing points on any part of the boundary leads to a redistribution of trafficking streams and to some reduction in the flow, on the other hand, it increases the total flow of goods across the border section reducing trade barriers.

Apparently, unobservable factors in the gravity model are associated with the individual characteristics of checkpoints such as an actual throughput, the complexity of customs control, the infrastructure, and convenience have a significant effect on the variation of bilateral trade flows.

Therefore, the gravity model of international trade can be used to describe the volume and the direction of trade flows and their dependence on a number of factors. Furthermore, some modifications developed by several scholars should be noted.

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For example, Akerman and Forslid entered GDP level per capita as an additional variable of the gravity equation (2). Chen and Novy introduced a multilateral resistance that varies in time and the modification of the model for panel data (Roy and Roy 191). It is also important to pinpoint that the income differences, infrastructure as well as exchange rates added to the standard gravity equation are significant variables of bilateral trade flows (Khorana 117). Finally, different availability of factors of production in the countries, the impact of government on the factor conditions, and the demand conditions play an integral part in bilateral trade flows.

GDP

A group of about 130 developing countries is determined by the lower in comparison with the developed countries indicators of GDP per capita, a lower proportion of the urban population, a high population growth rates, high infant mortality, and lower life expectancy.

One of the distinctive policies of their trade in the 20th century was the subordination to the strategic goals of the economic policy. The formation of the group of developing countries coincides with a period defined by the criterion of economic development success that was associated with its industrial stage.

More precisely, the economic development of developing countries was associated with the accelerated industrialization of developing countries, and industrialization was logically viewed as a key part of their overall strategy and long-term plans for economic development. Industrialization was expected to resolve the issue of employment, improve the technological level of the economy, and change the structure of the industry, international trade, exchange, and a number of other tasks.

In the initial period of orientation to industrial development, developing countries conceived it as a production for their own market. It seemed that market sovereignty was guaranteed by the government, and developed countries have submitted non-exhaustible sources of capital equipment (Schenk 58). Only years later, in the first half of the 1960s, they came to the understanding that the chosen path is the path of the import substitution industrialization, which is not so uniquely simple as some difficulties of complex product replacement appeared showing the narrowness of the domestic market and its ineffectiveness.

As a result, the opposite idea of the extrinsic orientation of industrialization that was reflected in the concept of export-oriented development emerged and became popular. At first glance, it helped to overcome the shortcomings of the import substitution as the problem of the narrowness of the market was eliminated and stimulus to increase the efficiency was provided. However, it became obvious that it is difficult to win the position in foreign markets because of the competition of developed countries and their protectionist policies in relation to exports of developing countries.

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In this connection, one might note the second policy of establishing export profits that determined the characteristics of developing countries’ trade policy. Based on the incomes from commodity exports, export was subjected to considerable annual fluctuations due to the volatility of raw material supply while the instability occurred due to the unstable situation in the world economy and price volatility (Jamali and Anka 47). The monocultural nature of exports of the majority of developing countries led to the fact that the global economic situation entailed more serious consequences for them than for developed countries.

Basically, with a high degree of openness of the economy, as measured by the ratio of the value of export to GDP, these fluctuations directly affected the GDP putting the very existence of some countries in a vulnerable position. The instability of export occurred in a long-term trend of trade deterioration, in other words, the reduction of its purchasing power. Such a tendency operated because of several reasons, for example, due to the lower elasticity of demand for raw materials compared with the elasticity of demand for prepared foods, the higher degree of raw market, and competitiveness in comparison with the market of final products that were often oligopolistic leading to the price asymmetry.

Works Cited

Akerman, Anders, and Rikard Forslid. “Firm Heterogeneity and Country Size Dependent Market Entry Cost.” Research Institute of Industrial Economics 2.1 (2009): 1-5. Print.

Bergeijk, Peter A. G. Van, and Steven Brakman. The Gravity Model in International Trade: Advances and Applications. Cambridge, UK: Cambridge UP, 2010. Print.

Jamali, Sobho Khan, and Lawal Mohammad Anka. “Trade Policy in Developing Countries: A Case Study of Nigeria and Pakistan.” OIDA International Journal of Sustainable Development 2.6 (2011): 45-52. Print.

Khorana, Sangeeta. Bilateral Trade Agreements in the Era of Globalization: The EU and India in Search of a Partnership. Cheltenham, UK: Edward Elgar Pub., 2010. Print.

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Roy, Malabika, and Saikat Sinha Roy. International Trade and International Finance: Explorations of Contemporary. New York, NY: Springer, 2016. Print.

Schenk, Rainer. Trade Policy of Developing Countries and Emerging Economies. New York, NY: Grin, 2013. Print.

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