Skip to main content

Adjustment Dynamics of Bilateral Trade Flows: Theory and Evidence

Summary

In this paper, I introduce a trade-promoting ‘invisible asset’ into the standard Krugman (1980) model of international trade. It can be interpreted as trust that accumulates as an externality in proportion to successful international transactions. I use this framework to theoretically derive a dynamic gravity equation and to discuss adjustment dynamics. I provide new evidence on adjustment rates of bilateral trade flows. On average, 23% of the gap to the steady-state trade flow are closed each year. However, dynamic regressions yield long-run trade policy effects which are comparable to static estimates.

References

  • Anderson, T. W., and C. Hsiao (1981), “Estimation of Dynamic Models with Error Components”, Journal of the American Statistical Association, 76, pp. 598–606.

    Article  Google Scholar 

  • Anderson, T. W., and C. Hsiao (1982), “Formulation and Estimation of Dynamic Models Using Panel Data”, Journal of Econometrics, 18, pp. 47–82.

    Article  Google Scholar 

  • Arellano, M. and S. Bond (1991), “Some Tests of Specification for Panel Data: Monte Carlo Evidence and An Application to Employment Equations”, The Review of Economic Studies, 58, pp. 277–297.

    Article  Google Scholar 

  • Baier, S., and J. H. Bergstrand (2007), “Do Free Trade Agreements Actually Increase Member’s International Trade?”, Journal of International Economics, 71, pp. 72–95.

    Article  Google Scholar 

  • Baier, S., J. H. Bergstrand, P. Egger, and P.A. McLaughlin (2008), “Do Economic Integration Agreements Actually Work? Issues in Understanding the Causes and Consequences of the Growth of Regionalism”, The World Economy, 31 (4), pp. 461–497.

    Article  Google Scholar 

  • Baldwin, R., V. DiNino, L. Fontagne, R. De Santis, and D. Taglioni (2008), “Study on the Impact of the Euro on Trade and Foreign Direct Investment”, European Economic and Monetary Union Working Paper 321.

  • Barro, R. J., and X. Sala-i-Martin (2003), Economic Growth. Cambridge, MIT Press.

    Google Scholar 

  • Beck, T., and R. Levine (2004), “Stock Markets, Banks, and Growth: Panel Evidence”, Journal of Banking and Finance, 28 (3), pp. 423–442.

    Article  Google Scholar 

  • Bond, S. (2002), “Dynamic Panel Data Models: A Guide to Micro Data Methods and Practice”, Portuguese Economic Journal, 1 (2), pp. 141–162.

    Article  Google Scholar 

  • Bond, S., A. Hoeffler, and J. Temple (2001), “GMM Estimation of Empirical Growth Models”, CEPR Discussion Paper 3048.

  • Carkovic, M., and R. Levine (2005), “Does Foreign Direct Investment Accelerate Economic Growth?”, in: T. H. Moran, E. M. Graham, and M. Blomström, Does Foreign Direct Investment Promote Development? Washington, DC: Institute for International Economics and Center for Global Development.

    Google Scholar 

  • Caselli, F., G. Esquivel, and F. Lefort (1996), “Reopening the Convergence Debate: A New Look at Cross-Country Growth Empirics”, Journal of Economic Growth, 1, pp. 363–389.

    Article  Google Scholar 

  • De Benedictis, L., and C. Vicarelli (2005), “Trade Potentials in Gravity Panel Data Models”, Topics in Economic Analysis & Policy, 5 (1), Art. 20.

    Article  Google Scholar 

  • De Grauwe P., and F. Skudelny (2000), “The Impact of EMU on Trade Flows”, Weltwirtschaftliches Archiv/Review of World Economics, 136, pp. 381–402.

    Article  Google Scholar 

  • De Nardis, S., R. de Santis, and C. Vicarelli (2008), “The Euro’s Effects on Trade in a Dynamic Setting”, The European Journal of Comparative Economics, 5 (1), pp. 73–85.

    Google Scholar 

  • Egger, P. (2001a), “European Exports and Outward Foreign Direct Investment: A Dynamic Panel Data Approach”, Weltwirtschaftliches Archiv/Review of World Economics, 137 (3), pp. 427–449.

    Article  Google Scholar 

  • Egger, P. (2001b), “European Integration in Trade and FDI: A Dynamic Perspective”, CESifo Forum, 2 (2), pp. 30–35.

    Google Scholar 

  • Egger, P., and V. Merlo (2007), “The Impact of Bilateral Investment Treaties on FDI Dynamics”, The World Economy, 30 (10), pp. 1536–1549.

    Article  Google Scholar 

  • Eichengreen, B., and D. Irwin (1998), “The Role of History in Bilateral Trade Flows”, in: J. Frankel (ed.), The Regionalization of the World Economy, University of Chicago Press.

  • Feenstra, R. C. (2004), Advanced International Trade: Theory and Evidence. Princeton, Princeton University Press.

    Google Scholar 

  • Guiso, L., P. Sapienza, and L. Zingales (2009), “Cultural Biases in Economic Exchange”, Quarterly Journal of Economics, forthcoming.

  • Krautheim, S. (2008), “Gravity and Information: Heterogeneous Firms, Exporter Networks and the ‘Distance Puzzle’”, European University Institute, Mimeo.

    Google Scholar 

  • Krugman, P. (1980), “Scale Economies, Product Differentiation, and the Pattern of Trade”, American Economic Review, 70 (5), pp. 950–959.

    Google Scholar 

  • Martinez-Zarzoso, I., F. Nowak-Lehmann Danzinger, S. Klasen, and M. Larch (2009), “Does German Development Aid Promote German Exports?”, German Economic Review. forthcoming.

  • Micco, A., E. Stein, G. Ordonez (2003), “The Currency Union Effect on Trade: Early Evidence from EMU”, Economic Policy, 18 (37), pp. 315–356.

    Article  Google Scholar 

  • Moser, C., T. Nestmann, and M. Wedow (2008), “Political Risk and Export Promotion: Evidence from Germany”, The World Economy, 31 (6), pp. 781–803.

    Article  Google Scholar 

  • Nickel, S. (1981), “Biases in Dynamic Models with Fixed Effects”, Econometrica, 49 (6), pp. 1417–1426.

    Article  Google Scholar 

  • Rauch, J. E. (1999), “Networks Versus Markets in International Trade”, Journal of International Economics, 48 (1), pp. 7–35.

    Article  Google Scholar 

  • Roodman, D. M. (2009), “A Note on the Theme of Too Many Instruments”, Oxford Bulletin of Economics and Statistics, 71 (1), pp. 135–158.

    Article  Google Scholar 

  • Staiger, D., and J. H. Stock (1997), “Instrumental Variables Regression with Weak Instruments”, Econometrica, 65 (3), pp. 557–586.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Benjamin Jung.

Additional information

I am grateful to Jose de Sousa, Peter Egger, Gabriel Felbermayr, Wilhelm Kohler, Marcelo Olarreaga, Davide Sala, and Dieter Urban for stimulating discussions, and to participants at a Workshop at the Center for Economic Studies (CES) in Munich, at the Annual Meeting of the Swiss Society of Economics and Statistics in Geneva, and at the Annual Conference of the European Trade Study Group in Rome for comments. Part of the paper was written when I was visiting scholar at The Leverhulme Centre for Research on Globalisation and Economic Policy (GEP). Financial support from the German Research Foundation (DFG) through a PhD fellowship is gratefully acknowledged. All remaining errors are mine.

Rights and permissions

Open Access This article is distributed under the terms of the Creative Commons Attribution 2.0 International License ( https://creativecommons.org/licenses/by/2.0 ), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Reprints and Permissions

About this article

Cite this article

Jung, B. Adjustment Dynamics of Bilateral Trade Flows: Theory and Evidence. Swiss J Economics Statistics 145, 421–442 (2009). https://doi.org/10.1007/BF03399289

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/BF03399289

JEL-Classification

  • F14
  • F15

Keywords

  • international bilateral trade
  • gravity model
  • trust
  • dynamic panel data