Gravity Model by Panel Data Approach

Publication Date01 Nov 2015
AuthorShahid Ahmed,Sushil Kumar
Gravity Model by Panel
Data Approach:
An Empirical Application
with Implications for
South Asian Countries
Sushil Kumar1
Shahid Ahmed2
This article has examined the determinants of export and import flows of coun-
tries in the South Asia through estimations for a country panel data of eight
countries during the period 1985–2011 using a gravity model. The estimated
result suggests that gross domestic product (GDP) and population among other
factors can explain export and import flows. Perhaps the most important finding
of the study is that South Asia Free Trade Agreement (SAFTA) has produced
trade creation among its members. Finally, the study found that geographic dis-
tance might be impeding trade, and tariff has negative effect on the trade. The
study also found that the nature of trade is intra-industry among the member
countries of South Asian Association for Regional Cooperation (SAARC).
JEL: F14, F15
Gravity model, panel data, SAFTA, regional integration
Over the past several decades, the global scene of international trade has witnessed
a significant lowering of trade restrictions by both advanced nations, and emerging
and transition economies. Such a momentous trend in trade liberalization has
Foreign Trade Review
50(4) 233–249
©2015 Indian Institute of
Foreign Trade
SAGE Publications
DOI: 10.1177/0015732515598587
Corresponding author:
Sushil Kumar, Research Scholar, Department of Economics, Jamia Millia Islamia, New Delhi 110 025,
1 Research Scholar, Department of Economics, Jamia Millia Islamia, New Delhi, India.
2 Professor, Department of Economics, Jamia Millia Islamia, New Delhi, India.
234 Foreign Trade Review 50(4)
stemmed from two approaches. The first approach is inherently multilateral and it
involves a reciprocal reduction of trade barriers on a non-discriminatory basis as
embodied in the General Agreement on Tariffs and Trade (GATT)—and its succes-
sor, the World Trade Organization (WTO)—and the second approach through the
formation of regional trading arrangement (or trade blocs) by a small group of
nations typically on a regional basis (Carbaugh, 2006). The trade induced by a
preferential trading agreement is the outcome of trade creation or trade diversion
or both. Trade creation is the substitution in the importing country of a lower cost
source of supply within the area for a more costly source and is, therefore, benefi-
cial to the member countries and the world as a whole. In contrast, trade diversion
is the substitution of more costly sources of supply within the area for less costly
sources outside the area (Viner, 1950).
Given the slow progress of Doha Round in the WTO, both developed and
developing countries have moved towards regionalism or bilateralism to cater to
their growth and developmental needs (Ahmed, 2011). As a result, the surge in
Regional Trade Agreements (RTAs) has continued unabated since the early 1990s.
In 2012, some 511 notification of RTAs counting goods, services and accessions
separately have been received or notified to the GATT/WTO. The basic reason for
this phenomenal growth of regionalism is attributed generally to the weakening of
multilateralism at a global level and slow progress at WTO forum right from its
inception (Ahmed, 2010).
To promote regional cooperation, the seven South Asian nations, Bangladesh,
Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka, formed the South Asian
Association for Regional Cooperation (SAARC) in December 1985. An agree-
ment on South Asia Preferential Trading Arrangement (SAPTA) was signed in
1993, which was operationalized on 7 December 1995, representing the first stage
of an integrative arrangement among the member countries of SAARC. As a result
of progress made by SAPTA negotiations, SAARC leaders at the 10th SAARC
summit in Colombo in 1998 decided to set up a committee of experts to draft a
treaty on South Asian Free Trade Agreement (SAFTA). The second stage of
regional trade integration was achieved during the 12th SAARC summit by an
agreement on SAFTA among member nations of SAARC in Islamabad from 4 to
6 January 2004. The SAFTA became effective on 1 January 2006.
The total export of the SAARC region increased from US$0.63 billion in 1985
to US$21.12 billion in the 2013, which was 5.72 per cent of South Asia’s global
export while intra-regional import of region was US$0.73 billion in 1985 and
increased to US$8 billion in 2013, which was 1.63 per cent of global import of
South Asia (see Figures A1 and A2 in Appendix). Intra-regional trade in South
Asia is merely 5 per cent as compared to 58 per cent in the European Union, 52
per cent in the North America Free Trade Agreement region, and 26 per cent in the
Association of South East Asian Nations (ASEAN) (Bhunia & Nataraj, 2014).
An empirical examination of the impact of different variables on the trade
flows in the region would help us to identify the fundamentals of trade flows,
which would be useful to frame the future trade policies. At present, South Asia
combines a low level of regional integration especially among the largest mem-
bers and the presence of relatively high trade barriers. The focus of the present

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