Evaluating Trade Theory: The Gravity Model Writing Assignment (Essay Sample)

Evaluating Trade Theory: The Gravity Model
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5/01/18
Introduction
Trade is a conceptual phenomenon that explains the exchange of services and goods among entities or people. Understanding international trade will require one to be conversant with relevant trade theories in order to not only grasp the idea of trade, but also be able to be to analyze relevant trade data, (Kemp, 2011). In this case, international trade is defined as a concept of exchanging services and goods between 2 distinguished countries through entities or people, (Anderson & Wincoop, 2001). Gravity model of trade is used to show how trade of a country increases with its partner country’s GDP, (De Benedictis & Taglioni, 2011). In this essay, focus will be directed to analyzing trade data that compares Trade in the United States and Canada. Through regression model, data collected will be analyzed and used to explain the gravity model. Software packages that have been used in analyzing the data are Eviews and Excel 2013.
Regression Model
The data to be analyzed through regression modelling is the trade and GDP data of all products that that were exported by Canada to the United States between the years 1989 to 2016. In this case, the reporter is Canada who are the exporters while the partner is the United States. The analysis involves GDP trade data that compares Canadian Trade with that of United States. The data below is the trade data of all the exports of Canada to United States. The data is an update of current US$ from 1989 to 2016. Regression analysis of the data features a regression scatter plot with a regression line. The chart below is a regression scatter plot with a regression line and an equation.
Scatter Plot with Regression Line
Through the statistic software, Eviews, we are able to find out the results below.
Table 3: Regression Analysis through Least Squares Method
According to the scatter plot, the trade is seen to increase with the economic size. This is basically illustrated through the gravity model where it states, the international trade of a country, which is involved in international economics, can be predicted by its flow of bilateral trade flow by focusing on the economic size and the distances that exists between the two units being analysed, (Krugman, Obstfeld, & Melitz, 2014). This regression has a high R squared value of 0.819197 which translates to 82%.
The model is homoscesticity and the residuals are normally distributed since the regression line is showing increase. Since the features of a perfect regression are clearly passed with the analysis, then forecasting using this analysis since the null hypothesis is desirable, (Besanko & Braeutigam, 2007).
The guideline states that if the t is more than 5% then we will accept null hypothesis. In this case, the R squared is more than 60% meaning that the data is nicely fitted. The P value of the data analysed of the Trade variable is 0% which means it is not significant. It is more than 5% which is the maximum guideline for a significant P value, (Krugman, Obstfeld, & Melitz, 2014). Therefore, Trade variable is significant explanation of the GDP variable. The regression model is still termed as the best regression model since the significant variable which is Trade value: 100% of the variable is significant, (De Benedictis & Taglioni, 2011). The F-statistic is significant since the P value of the corresponding F statistics is less than 5%: 0%.
Gravity Model Discussion
From the 1980 data, it is clear that Canada was able to trade more with United States, (Besanko & Braeutigam, 2007). The Border had an exerted strong effect of the pattern of trade between the two countries making it evident although is it argued that if there could be the existence of the Canada-US Free Trade Area. However, there is evidence of significance and sustainability of bilateral trade from the projection of analysis through the early 1990s though it increases with increase in GDP, (Feenstra & Taylor, 2017).
However, if there is embrace to globalisation rather than regionalisation, then having a borderless world will help in boosting the economy of Canada as reflected with the GDPs of both countries. Generally, the United States economic data reveals that the GDP increases every year as well as trade due to demand of commodity and the growth of population. The same reflects in Canada where through its exports, the economy is projected to increase making it easier for forecasting the trade capabilities or rather the prediction of future trade, (Dr. Anukoonwattaka, 2015).
Through globalisation, the flow of trade will be easier. The financial capital, production activities as well labour will be flowing easily between United States and Canada creating an accurate picture of a global village. According to studies that assess the global value chain, (GVC), it is clear that the extensive changes that might be done to world trade have the ability of affecting the export market by creating competition.
The impact is estimated to be huge especially in the exporters that are in the GVC, (Feenstra & Taylor, 2017). One of the industry that is involved in the GVC is the agricultural industry where there is huge competition that Canada is likely to meet from European countries as well as other countries such as United States and Mexico, (Dr. Anukoonwattaka, 2015).According to the gravity model, the estimation of amount of interaction of Canada and United States is based on the activities that the both countries involve themselves in, (Walsh, 2006). The attraction of the United States and Canada will be based on the distance they are from each other and the volume of products exported to the others market, (Gandolfo, 2014). In this study, Canada is the exporter of products and its interaction are high affected by the trade activities of the United States.
Importance the Model of Trade
The importance of this model of trade is based on the fact that the interaction of the United States and Canada is geographically affected by the fact that they are neighbouring countries sharing a border. In this case, focusing on not only globalisation, but also understanding the potential effects of export and import tariffs is important, (Husted, Melvin, & Suarez, 2001). Therefore, the export trade activities of Canada to United States is highly affected by competition which greatly influences the ability and strength of the economy. In this case, the attraction is based on the demand of commodities as well as the support of the gravity equation which shows that as the GDP increases, there is an increase of trade, (Walsh, 2006).
Gravity Model helps in projecting the economic ties that Canada and United States need to develop great economic empire through trade, (Walsh, 2006). In this scenario, there is a clear and stable interactions that is based on the great network of export link that has been created among the countries over time. United States has been able to acquire more products from Canada boosting the connection through the business transactions thus boosting the trade, (Walsh, 2006).
Strength and Weakness of Gravity Model in the Trade Theory
The strength that the gravity model has over the trade between United States and Canada is the transport cost. The distance plays a major role in export of products from Canada to the United States. The distance being short compared to other countries such as European countries, it is easier for the United States to access the products from Canada since the distance is flexible and transportation is easier and time saving. In most cases, there are always challenges that are related to time delays of export and importation trade facilities.in this case, the creation of free trade area allows easy access of products from Canada and exportation of good from United States thus boosting the economic growth of the country. These interactions are greatly influenced by the regional integration agreements that the United States have with Canada. The Currency Union which has both United States and Canadian Dollars to be used internationally plays a major role in impacting the trade cost.
Significantly, there are limitations of the gravity model where there is a high friction experienced during importation and exportation as far as tariffs and non-tariff barriers are concerned. Some commodities such as medical equipment and medicinal drugs attract high tariffs making it hard for Canadian industries to factor this exports to the market. This is high projected by the political structures of both countries. Corruptions highly affects the import and export business thus impacting the international trade. Contract enforcement are unclearly served thus discouraging transparency in the economic structure thus affecting trade negatively.
Conclusion
Inclusion, the higher the value of country’s partner’s GDP, the higher the trade with the partner country. Through regression modelling, the set of data collected between Canada and United States show an estimate or rather establish the relation of the variables. In this case, analysis is based on determent of how the GDP behave when the independent variable is varied. Through the analysis, the Canada-US border has a huge impact to the trade of the both countries. In this case, the border has a limiting effect on the trade due to asymmetric though its effects are different across different provinces. Therefore, when analysing the trade trends of Canada and comparing it with its partner United States, it is clear to not that the distance is between the two has a role to play in the growth of the trade. From the regression equation it is easy to identify that the standard gravity model that was used in obtaining the results was not biased to the volume of trade since it is attributed to b...