The Impact of Regional Trade Agreements on International Trade

doi:10.4236/me.2011.25094

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Modern Economy, 2011, 2, 846-849

doi:10.4236/me.2011.25094 Published Online November 2011 (http://www.SciRP.org/journal/me)

The Impact of Regional Trade Agreements

on International Trade

Yutaka Kurihara

Aichi University, Department of Economics, 1-1 Machihata Toyohashi, Aichi, Japan

E-mail: [email protected]

Received August 31, 2011; revised October 9, 2011; accepted November 9, 2011

Abstract

The gravity model of international trade states that bilateral trade flows based on the economic sizes and

distances between two units can be used to examine reasons for international trade. Regional Trade Agree-

ments (RTAs) have appeared recently and have increased markedly in number; however, despite their

importance, little study has been performed to analyze the effects of RTAs on international trade. The

difference between RTAs and world trade organizations (WTO) is important. Studies of currency integration

have appeared recently; however, most assume that currency integration varies the level of international

trade between countries by making the proportion constant. This paper eliminates this so-called constant hy-

pothesis and indicates that RTAs alters the slope of the relationship between countries and promote interna-

tional trade. Empirical analysis indicates that the proportion is not constant. Also, this study shows that

RTAs promote international trade more in OECD countries than in non-OECD countries.

Keywords: International Trade, Gravity Model, RTAs, WTO

1. Introduction

In general, the GATT and WTO have been thought to

ensure a level playing f ield of all, thereby con tributing to

economic growth and development. However, the pro-

liferation of regional trade agreements (RTAs) in recent

decades threatens the future of the multinational trading

system because the exclusive trade preference of RTAs,

although approved under the provisions of the GATT,

are not consistent with an important principle of the

multinational trading system, the most favored nation

principle, and causes discriminatory trade practices of

trade disciplines [1]. RTAs have increased markedly in

number and hence have become a very important aspect

of the multinational trading system [2].

The gravity model of international trade states that bi-

lateral trade flows are based on the economic sizes (often

using GDP) and distance between two units (countries).

The model also has been used repeatedly in international

relations to examine the effectiveness of currency unions

and regional agreements. The model is often extended by

including variables to explain language relationships,

contiguity, colonial history, exchange rate regimes, and

other variabl es.

The gravity model has been introduced and cited many

times. Not only academic fields but also real-world re-

searchers have stated that patterns of trade will be

determined by aggregate preferences for goods within

countries. [3] stated that if trade encourages greater spe-

cialization in production, industry-specific shocks may

cause members’ business cycles to diverge and that com-

parative advantages do not predict th e relationships in the

gravity mode l. Alternativ ely, [ 4] de monstrate d that gre ater

trade integration may help correlate national incomes.

[5] showed that the creation of RTAs provides trade

preference to member countries to promote bilateral

trade. [6] found that expansionary ASEAN + 3RTAs

could be a sustainable policy option. [7] demonstrated

that the EU may increase trade performance in several

industries. [8] showed that pro-labor predictions of the

median voter model are supported by the full-fledged

FTA. [9] showed that a gravity model suggests that the

creation of AFTA, COMESA, and MERCOSUR have

increased trade in agriculture between their members.

However, [10] showed that RTAs are not an efficient

way to promote international trade. On the other hand,

there has been little study that has analyzed RTAs using

the gravity model in spite of the fact that this model for

internationa l trade has been used a lo t. One of the reasons

is that RTAs are recent phenomenon in the world.

847

Y. KURIHARA

In these cases, the slope of the bilateral trade-GDP re-

lationship may change when RTAs ar e adopted. It is very

natural to think so. Moreover, to the extent that trade

integration encourages greater production specialization,

RTAs might permit the exploitation of economies of

scale in transportation; information, communication and

technology (ICT); and so on, changing the slope of the

bilateral trade relationship.

As noted in [11], as existing RTAs are deepened and

new ones are being negotiated, it will be important to

ensure that trade creation dominates trade diversion. It is

therefore essential to examine the effects of RTAs.

This article is organized as follows. The next section

shows theoretical analysis on this issue. Section 3 dem-

onstrates the empirical methods and the data used here.

Section 4 shows the results and performs additional ana-

lysis on the results of previous section. Finally this paper

ends with a brief summary.

2. Theoretical Analysis and Empirical

Methodology

This paper’s fixed effect model is similar to [12,13].

ln(TRADEijt) = a0RTAijt + a1ln(YiYj) + a2ln(P CiPCj) +

a3CUijt +μij + εijt (1)

where i and j are countries (units), TRADE is the value

of bilateral trade, RTA is a dummy variable that is unity

if countries belong to the same regional trade agreement.

Y is the product of their real GDP, PC is the product of

real GDP per capita, CU is a dummy variable that equals

one if these countries use the same currency. Finally, μ is

the country-pair fixed effects. μij assumes that μij = μji;

the fixed effects do not depend on the direction of inter-

national trade. Panel data for all over the world is used

except for missing cases.

RTAs nonlinear effects may arise as a result of selec-

tion into agreements for international trade by countries

that tend to be small, poor, and remote. The impact of a

change in RTA condition or slope coefficient is exam-

ined in the next section.

I used th e panel data for OECD and non-OECD coun-

tries. The sample data are from 1985 to 2009. All the

data are yearly. RTAs and member countries were ob-

tained from the membership of proliferation of regional

trade agreements by the WTO. All other data are from

International Financial Statistics (IMF), World Devel-

opment Indicators (World Bank). Finally, if there were

insignificant variable(s), I omitted this (these) variable(s),

estimated again, and computed the RTAs’ effects on in-

ternational trade

3. Estimated Results and Revised Estimation

The results of Equation (1) are shown in Table 1.

The results are almost as expected. Colu mns (1) an d (4)

in Ta ble 1 show that the estimated coefficient for RTA is

0.815 (OECD) and 0.798 (non-OECD). Both are positiv e

and significant. RTAs certainly promote international

trade. It is interesting to note that the effect is bigger for

OECD countries than for non-OECD countries.

The effects of nonlinear RTAs may arise as explained

in the previous section. Next, quadratic terms of ln(YiYj)

and ln(PCiPCj) are added as in [13], for the case of cur-

rency integration. Th e results are in columns (2) and (5),

which demonstrates that both variables are positive and

significant and confirms nonlinearity. The analysis is

performed later.

I investigated the impact of a change in the condition

of the RTAs by adding the following interaction terms: 1)

RTA and ln(DISTij), where DISTij is the distance be-

tween countries, 2) RTA and ln(YiYj), and 3) RTA and

ln(YPCiYPCj). The quadratic terms and the interaction

term of RTA and ln(YiYj) are significant at the 1% level;

the introduction of RTAs changes the relationship be-

tween tra d e and GDP in OECD and non- O ECD co un tr ies .

On the other hand, the changes in relationships between

trade and GDP per capita and trade and distance are not

significant.

It is interesting to note that the relationship between

international trade an d distance is insignificant in OECD

countries; however, they also are significant in non-

OECD countries. As transportation system and ICT im-

prove, the effect of distance on international trade may

decrease. In OECD countries, distance is still an impor-

tant factor in the promotion of international trade.

I excluded the insignificant variables and computed

the effect of the RTAs. The calculation equation is as

follows [13]:









RTARTA ln()

RTAEFFECT expln1

ijtY Yij

aa YY







(2)

The equations shows how the RTAs effects (RTAEF-

FECTijt) are distributed where both countries are mem-

bers of the same RTAs (i.e., RTAijt = 1). The results are

0.780 for OEC D a nd 0.7 1 3 fo r no n- OECD countrie s.

There is high possibility that RTAs do not reduce bi-

lateral trade if a large country is involved. However, it

should be noted that although some country pairs ex-

perience substantially higher levels of trade when they

share a common RTAs, for a significant subset of coun-

try pairs, members of RTAs are associated with a lower

level of bilateral trade. How RTAs promote international

trade depends on the constitutio n of the pair of countries.

RTAs surely promote international trade; however, the

proportion is not necessarily proportional. Each country

should consider this fact and use it effectively to gain

Y. KURIHARA

848

Table 1. Estimated results for gravity model of international trade.

OECD Non-OECD

(1) (2) (3) (4) (5) (6)

RTA 0.815***

(20.125) 0.740***

(19.999) 0.731***

(19.351) 0.798***

(18.530) 0.722***

(18.023) 0.725***

(18.150)

ln(YiYj) 0.456***

(30.126) 0.412***

(27.652) –3.010

(–1.202) 0.470***

(29.319) 0.444***

(24.873) –2.904

(–1.105)

ln(PCiPCj) 0.530***

(9.182) 0.602***

(9.937) –0.685

(–0.973) 0.541***

(9.362) 0.610***

(9.948) –0.623

(–0.451)

CU 0.535***

(4.883) 0.560***

(5.100) –1.630

(–1.067) 0.535***

(4.883) 0.605***

(5.918) –1.432**

(-2.067)

ln(YiYj)2

0.035***

(9.187) 0.088***

(11.258)

0.039***

(9.392) 0.0899***

(13.458)

ln(PCiPCj)2

0.059***

(6.352) 0.058***

(6.234)

0.063***

(6.438) 0.060***

(5.922)

RTA* ln(YiYj)

0.125***

(4.624)

0.143***

(5.082)

RTA* ln(PCiPCj)

–0.070

(–0.770)

–0.055

(–0.342)

RTA*ln(DISTij)

0.150

(0.372)

0.333***

(6.080)

RTAs effect 0.801 0.680 0.823 0.821 0.693 0.844

Adj.R2 0.789 0.812 0.818 0.725 0.756 0.704

DW 1.898 1.903 1.912 1.822 1.844 1.876

Note: Numbers in parentheses are t statistics. ***Denotes significant at 1%, **at 5%, and *at 10% level.

from international trade.

4. Conclusions

I have provided evidence regarding the need to account

for slope effects when specifying gravity models to esti-

mate the impact of RTAs on bilateral trade. RTAs pro-

mote international trade more in OECD countries than

non-OECD countries. Finally, for the results of distribu-

tion of RTAs effects, it should be noted that the poten-

tials for RTAs are different. Whether and how RTAs

promote bilateral trade depends on the constitutio n of the

countries involved.

There is some room yet for further study, however. I

treated the RTAs the same way in all cases; however,

there are large differences among them. The content is

different in each case. Also, the relationship between

RTAs and WTO should be examined deeply and care-

fully. To ensure that RTAs do not undermine the multi-

lateral trading system, the WTO can oversee them by

using its political judicial review procedures. There is

likely to be some differences between developed, devel-

oping, and emerging countries. To focus on these issues,

for example, would be interesting. Finally, as RTAs have

developed recently, the sample period is too short to in-

vestigate it adequately. Time is needed for analyses.

Further research is need ed in this field.

5. Acknowledgements

I thank an anonymous referee for the comments and

suggestions.

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