Gravity models: a reformulation and an application to discriminatory trade arrangements

Abstract

Gravity Models are used to estimate trade flows from 162 countries into 11 major importing countries for 1976, counting the EC as one. The main theories underlying gravity models are reviewed and a new gravity model is derived from a linear expenditure system. A major innovation of this model is that both tariffs and dummy variables for discriminatory arrangements are incorporated. Price variables are also explicitly included in the model. The tariff and the dummy variables are found to be statistically significant and this indicates that previous gravity model studies which used dummies to estimate the trade benefits of preferential tariffs may not have accurately estimated the effects of the preferences. The price variables generally are also found to be statistically significant, which casts doubt on the homogeneous-goods assumption underlying the purchasing power parity hypothesis. Some significant differences in the estimates were found when separate equations were regressed for the EEC and the US.