International Trade Under the Light of Gravity Model

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International Trade
In light of the gravitational model

Submitted to Nawaz Ahmed
Abbas Tirmizi (8259)
Ebaad Ahmad (8611)
Rana Shahbaz (7369)
Faizan Qurieshi (9350)
Umer Bilal (8202)


The main purpose of this paper is to assess the impact of various factors on bilateral trade. To accomplish this purpose, using the standard gravity model, we ran regressions on bilateral goods trade for Pakistan to other economies for five years, 2005 to 2009. The results show that the gravity equation for trade is significantly impacted by the selected variables. Among others, we found that geographical distance is consistently more important for goods trade. This result may indicate that the cost of transport for tradable goods is “in general” higher but important. The result also shows that the GNP of the countries plays no significant role in the trade flows, whereas the distance, language and adjacency have some significance. This result may reflect the existence of trade in factor services which helps increase the exports of goods.

Key Words: Geographic, Cultural Factor, Flow of International Trade, Gravitational Model

1. Introduction
Industrialization, advanced transportation, globalization, multinational corporations and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders. International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture. Several different models have been proposed to predict patterns of trade and to analyze the effects of trade policies such as tariffs. The Ricardian model focuses on comparative advantage, perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods. Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The main merit of Ricardian model is that it assumes technology differences between countries. Technology gap is easily included in the Ricardian and Ricardo-Sraffa model. The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. The H-O theory stresses that countries should produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. This theory differs from the theories of comparative advantage and absolute advantage since those theories focus on the productivity of the production process for a particular good. On the contrary, the Heckscher-Ohlin theory states that a country should specialize in production and export using the factors that are most abundant, and thus the cheapest. Not to produce, as earlier theories stated, the goods it produces most efficiently. New Trade Theory tries to explain empirical elements of trade that comparative advantage-based models above have difficulty with. These include the fact that most trade is between countries with similar factor endowment and productivity levels, and the large amount of multinational production (i.e. foreign direct investment) which exists. New Trade theories are often based on assumptions like monopolistic...
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