International Markets Institutions and Policy - Example

International Markets Institutions and Policy xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Lecturer xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Introduction The theoretically derived gravity model as described by Anderson and van Wincoop in "Gravity with gravitas" (2003) is a gravity model used in international trade flows. This is a frequent approach in modelling joint and mutual trade flows. One of the weaknesses of this model is its theoretical base as well as poor micro foundation. The gravity equation that was used for describing the trade flows was first made in empirical literature. There were no many attempts to justify the theoretical perspective of the model. Support for this gravity model was at first very poor and low. Support came to improve in second half of 1970s, (Santos & Tenreyro 2004). This is after numerous theoretical developments were made to fill the gap that existed. This report undertakes to bring out the superiority of the theoretically derived gravity model as described by Anderson and van Wincoop over the empirically based gravity model. Superiority of theoretically derived gravity model Anderson and Van Wincoop (2003) model is one of the most frequently used empirical work. This model sets out the gravity model; it emphasizes the theoretical underpinnings and the important role that it plays in simulation, inference and driving estimation in applied work. Gravity with gravitas is the ingredients that are needed in order to put together a gravity form with gravitas. The tricky part is to combine them in the right way, (Anderson & Wincoop 2003). It is generally apprehensive with bilateral trade value (the exports from one country to another in respect to a specific product variety). Anderson and Van Wincoop formulation is one of the important benchmarks. It is not only used for estimating equations but also for justifying the theoretical gravity model. The gravity model has been in use from 1940s. The theoretical gravity model has been applied to a wide range of goods as well as factors of production. It has been applied to factors and goods moving across national and regional boundaries under diverse situation and conditions. The theoretical gravity model used for trade is quite similar to the physics model. They are similar in that the trade flows involving two countries is relative to the produce of each country's economic accumulation that is usually calculated by the gross domestic product (GDP), each one to the power of capability to be determined, (Baldwin et al. 2007). This is then divided by the distance between these country's economic centers of gravity (their capital city) raised to the power of another quantity to be determined as (Christie 2002) underpins. Anderson and van Wincoop (2003) derived on operational gravity model. They based it on manipulation of the constant elasticity of substitution (CES) expenditure system (this can easily be estimated). It helps to solve border puzzle. Though this theoretically derived gravity model is sometimes frail, it provides a very strong point for considerations and determination of econometric analysis of trade flows. The theoretical foundations of this gravity model are specific to the types of goods and products that are determined. The empirical performance is as well specific to goods examined. As such, it indicates that, the theoretical derived gravity model depends wholly on the assumption of the differtiated products. It is concluded that this model is also derived from the reciprocal dumping form in trading homogeneous products. This theoretical gravity model equation produces lower domestic income elasticity for the exports of homogeneous products than those for the differtiated goods. The reason for this is the effects of the home market effects; they depend significantly to the barriers to entry. In their work, Anderson and van Wincoop (2003) singles out the effects of the home market effects using the cross sectional gravity equation. They found out that the elasticity of the domestic income export is indeed considerably advanced for the differtiated products than for the homogeneous goods. As such, they brought out some several issues present for measurement in trade. Such issues like the cost of trade (national borders pose barrier to trade), the explanation of the trade patterns, the effects of regionalism and computation of trade potentials were found to have profound effects on trade flows between countries. This was essential in development of this theoretical gravity model. The theoretical derived gravity model is superior to empirically based gravity model by the way that it is relatively easy to derive. The models recognition of the nontariff barriers as more problematic than the tariff barriers has enabled countries to work in simplification of the trade flows between themselves. This has improved trade. The model identifies two issues as having considerable effects on trade between two countries, the distance between them and the economic sizes of the countries involved. The theoretical derived gravity model is superior in to the empirically based gravity model in that it is more usable in measuring the bilateral trade flows. It is used in all types of market conditions and structures, thereby making it to be superior. This gravity model brings out issues in international trade, it estimates the cost of a border, it explains the trade patterns, identifies and recognizes issues that are related to regionalism and notably, the tribulations trade potential. This model provides information for making decision on whether to pool or not to pool data. It helps and assists in interpretation of reduced form elasticity depending on the theoretical results derived thereon, (Pail et al. 2011). Essentially, theoretical derived gravity model general equilibrium basis provide a holistic way of determination of trade flows, it is the best predictor of bilateral trade flows as well as geographical distance between two countries. Implications One of the implications of the superiority of the theoretically derived gravity model is the trade costs. The definition of these trade costs affects the price of the goods, whether they include all the costs that are involved in transporting the products from the producer to the final consumer or only account part of the costs. The local distribution costs and the international trade costs dominate the marginal cost of production, (Anderson 2010). However, trade costs vary from one economy to another. Trade costs are higher in developing countries than in developed countries. The product lines also affects the trade costs, as such this model have effects on the costs that are involved in trade flows between countries. Trade costs determine the unit price of goods and may increase the cost of a good. This has effects on the rate of inventory turnover and consequently the income (income determines the success of a trade flow). The approach that the gravity model utilizes to e valuate the effects of the trade of regional and bilateral agreements, the gravity model utilizes extensively the trade effects in terms of the size of the economies and the distance between them. Hence the volume of trade between two countries I affected by the culture, language and distance. As such, the gravity model measures the effects of trade and the different features of trade. Lack of foundation of the theoretical gravity makes its estimation to provide biased results due to omission of some variable issues. It also makes it not possible to exercise the comparative statistics as one has to evaluate the trade effects before and after the trade barriers are removed. The theoretical gravity model contains the multinational resistance. This is essential as it captures the incentives of trade between two countries, however, it cannot be quantified or be observed. The distance between the capitals of trading countries plays a big role in determination of the success of the trade flow between the trading countries, (Baier 2008). The common currency in the international trade is another implication of the theoretical gravity model. The common currency in a country decreases or increases the transactional cost and thus the trade may be beneficial to one country and costly to the other country. Intuitively, the formation and existence of trading blocs increase trade volumes and balance the effects of common currency on the trade flows. It is therefore plausible to evaluate the trading blocs before and after countries leave or join currency unions, (Anderson & Van Wincoop 2001). Decreasing the trade barrier between countries increases the volume of trade; this is done though the theoretical derived gravity model hence ascertaining the necessity and superiority of this model over the empirical model. The theoretical derived gravity model uses the theoretical gravity equation to measure the size of the bilateral and regional trade flows. Fij = volume of trade Mi and Mj = mass of countries Dij = distance With good infrastructure development, the cost of trade between countries is considerably reduced. According to the theoretical derived gravity model, there are two important aspects in econometrics in trade flows, the creation of trade and diversion of trade. These two aspects have comparative advantage to the countries involved in trade flows; they have profound effects on bilateral and regional integration. Conclusion Conclusively, the theoretical derived gravity model as in Anderson and van Wincoop "Gravity with gravitas" (2003) is superior to the empirically based gravity model. The theoretical gravity model provides a good base for decision-making provides and determines better prediction of bilateral trade flows as well as geographical distance between two countries. References Anderson, J, & Van Wincoop, E, 2001, Gravity with gravitas: a solution to the border puzzle: National Bureau of Economic Research. Anderson, J, 2010, the gravity model: National Bureau of Economic Research. Anderson, J, and Wincoop E, V 2003, “Gravity with Gravitas: A Solution to the Border Puzzle”, the American Economic Review, Nashville. Baier, S, (2008), “Do Economic Integration Agreements Actually works”, The World Economy (2008). Baldwin, Richard E, and Daria Taglioni, 2007, “Trade Effects of the Euro: A Comparison of Different Estimators”, Journal of Economic Integration, 22(4), 780-818. Pail, R, Bruinsma, S, Migliaccio, F, Förste, C, Goiginger, K, 2011, first GOCE gravity field models derived by three different approaches, Journal of Geodesy, 85(11), 819-843. Santos Silva J, and Tenreyro S 2004, “The Log of Gravity”, FRB Boston (2003). Read More