An Econometric View on the Estimation of Gravity Models and the Calculation of Trade Potentials

I N the last decade, the application of gravity models enjoyed a big revival. This was not so much driven by its more rigorous theoretical foundation (Anderson, 1979; Bergstrand, 1985, 1989 and 1990; Helpman and Krugman, 1985; and Helpman, 1987, etc.) but by the opportunity to project bilateral trade relations (see Wang and Winters, 1991; Hamilton and Winters, 1992; Baldwin, 1994; and successors). The first applications were undertaken within the context of the Fall of the Iron Curtain and the new potential integration effects between the EU (OECD) and the former COMECON member states. According to the traditional concept of the gravity equation, bilateral trade can be explained by GDP and GDP per capita figures and both trade impediment (distance) and preference factors (common border, common language, etc.). The economic framework in most cases was cross-section analysis (Wang and Winters, 1991; Hamilton and Winters, 1992; Brulhart and Kelly, 1999; and Nilsson, 2000, etc.). Only a few authors made use of (random effects) panel econometric methods (Baldwin, 1994; Gros and Gonciarz, 1996; Mátyás, 1997; and Egger, 2000). Two conceptually different approaches were followed. First, some authors argued that in the initial stage of the systemic and economic transformation, e.g. of the Central and Eastern European countries (CEEC), these countries behaved differently from developed countries such as the EU or OECD members. A gravity model was estimated for EU or OECD countries and the parameters were used to project ‘natural’ trade relations between these countries and the CEEC.