Kahouli, Static Gravity Model

Journal of East-West Business
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Regional Trade Agreements in Mediterranean

Area: Econometric Analysis by Static Gravity Model
Bassem Kahouli & Samir Maktouf
To cite this article: Bassem Kahouli & Samir Maktouf (2013) Regional Trade Agreements in
Mediterranean Area: Econometric Analysis by Static Gravity Model, Journal of East-West Business,
19:4, 237-259, DOI: 10.1080/10669868.2013.794380
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Download by: [Australian Catholic University] Date: 22 October 2017, At: 01:34
Journal of East-West Business, 19:237–259, 2013
Copyright © Taylor & Francis Group, LLC
ISSN: 1066-9868 print/1528-6959 online
DOI: 10.1080/10669868.2013.794380
Regional Trade Agreements in Mediterranean

Area: Econometric Analysis by Static
Gravity Model
BASSEM KAHOULI
Faculty of Economics and Management, University of Sousse, Sousse, Tunisia
Downloaded by [Australian Catholic University] at 01:34 22 October 2017
SAMIR MAKTOUF
Faculty of Economics and Management, University of Tunis El Manar,
Tunis, Tunisia
Since the mid-1980s, there was the rise of a new wave of economic
regionalism in the world economy with the spread of free trade
agreements (FTAs). A key objective of free trade involves developing
commercial exchanges between member countries. The gravity
model is a vital tool to explain the bilateral trade data against the
variables of the relative size of the pair of countries implicated in
the trade: distance, common border, and language and models for
each of the FTAs. This article focuses on studying the influence of
FTAs in the Mediterranean countries in which we integrate the role
of regional dummy EU (15), EMU (euro zone), the AMU and
AGADIR agreement in trade flows. The use of regional variables are
designed to determine whether its FTAs contribute to the creation of
trade diversion. This study examines a cross-section and panel of
27 countries for 1980–2011. The results show the existence of a
strong relationship between the factors of FTAs and trade flows.
KEYWORDS FTA, gravity models, regional trade blocks
Received February 7, 2013; revised March 25, 2013; accepted April 6, 2013.
Address correspondence to Bassem Kahouli, Faculty of Economics and Management,
University of Sousse, BP 307, Riadh, 4023 Sousse, Tunisia. E-mail: kahoulibassem@yahoo.fr
237
238 B. Kahouli and S. Maktouf
INTRODUCTION
One of the most remarkable phenomena in the world economy during the last
20 years has been substantial growth in the number of economic integration
agreements (EIA). Regional trade agreements (RTAs) are treaties between econ-
omies and/or regions to reduce the control of the flow of goods and services,
political barriers, capital, labor, and so on (Baier et al. 2008). Most EIAs tend to
be regional in scope, and most tend be preferential trade agreements. Dated
July 31, 2010, 474 RTAs have been notified to the World Trade Organization,
and 283 agreements were in force. The FTA1 is the most important part of the
RTA. There are three main types of FTAs: North-North, North-South, and South-
South. FTAs North-North relate only to the developed economies. The European
Union is a good example of North-North FTAs. The North-South FTAs involve

both the developed and development. One of the most important North-South
FTAs is the North American Free Trade Agreement (NAFTA), including the
United States, Canada, and Mexico. Finally, the FTA South-South’s only concern
in developing countries. The FTA between the Eastern Asian Nations (ASEAN)
and the Euro-Mediterranean agreement of free trade is one of the most impor-
tant for South-South FTAs in the world. In the same order of idea, Kahouli and
Kadhraoui (2012) show that there are several reasons which countries or econ-
omies sign FTAs. Among the many reasons cited: First, extend the bilateral
trade between the partners; second, improve the efficiency and competitive-
ness of their goods and services sectors; third, develop trade flows and foreign
direct investment (FDI) between partners, which promotes economic growth
(Azman-Saini and Baharumshah 2010); fourth, encourage the expansion and
diversification of trade between the parties.
Given their importance in the economy, it is necessary to analyze the fac-
tors that are determinants of international trade flows2 between partners. In this
perspective, this paper uses an approach based on the application of the law
of gravity to the study of international trade flows and the effects of regional
integration on trade relations.3 Several previous studies have shown that the
gravity equation is a successful model to explain the structure of regional trade,
as it integrates the advantages related to theoretical and empirical modeling.
The work aims to study international trade flows of the countries involved in
the process of regional integration (in particular, FTA), focusing on the analysis
of the Mediterranean region. The effects of FTAs in the study region are treated
as deviations from the expected volume of trade by the gravity model. The task
of the study is to prove the assertion that the countries of the Mediterranean
region form a regional panel of countries that are involved in the RTA.
In this paper, we extend the existing literature on international trade by
introducing two levels of analyses in the measurement of FTA success in the
Euro-Mediterranean area. First, we estimate a simple gravity model (without
regional dummies) by using an ordinary least squares (OLS) regression and
static estimation. On the other hand, we introduce regional dummies vari-
ables (such as European Union [EU-15]; European Economic Monetary Union
Regional Trade Agreements in Mediterranean Area 239
[EMU]; Arab Maghreb Union [AMU]; and AGADIR agreement). In the same
order, we analyze the effect of creating and diversion trade on the FTAs in
the Mediterranean region.
This work is divided into five parts. Following this introduction, section
two describes the theoretical and empirical studies using gravity equations to
explore international trade flows. Section three presents the data and model
specification. The results of econometric models are presented in the fourth
section. Section five presents the conclusions and policy recommendations.
BRIEF LITERATURE REVIEW

The emergence of the gravity models of international trade has been intro-
duced by Tinbergen (1962) and Pöyhönen (1963. In the first stage, the grav-
ity equations did not have a solid theoretical basis but were widely used.
Hemkamon (2007) points out that the reasons for the intuitive application of
a gravity model for the modeling of international trade are as follows. First,
developed countries also have more international trade than developing
countries, as more goods and services are produced and demanded by them.
Second, the goods produced and exported by the more developed countries
often have higher quality and therefore are more expensive. In terms of
importing countries, only rich countries can afford to purchase these prod-
ucts. Third, the main factor in pushing gravity models (the distance between
the trading partners) expresses not only transportation costs but also other
possible conditions that may affect bilateral trade (cultural traditions, common
language, colonial background, etc.). It is easier to sell property in a neigh-
boring market, since the neighbors are better known.
The theoretical foundation of the gravity model was not produced until
the late 1970s. This has led to numerous studies and various improvements in
modeling and their application in the debates on the theoretical foundations
of the gravity equation. The model is shown as a serious empirical tool for
exploring the structure of regional trade. In addition, theoretical consider-
ations for the use of gravity models to explore international trade flows have
been largely developed by Anderson (1979), Bergstrand (1989, 1990), Deadorff
(1998), Evenett and Keller (2002), Anderson and van Wincoop (2003), Harrigan
(2001), and Hanson and Xiang (2004). In this context, Deardorff (1995)
pointed out that the gravity model is compatible with a wide range of busi-
ness models, including also the Heckscher-Ohlin trade is hampered with or
without friction. The recent wave of theoretical work has also led Cheng and
Wall (2005) that the gravity equation has gone from an embarrassment of
poverty theoretical foundations to an embarrassment of riches. In the same
order, Hemkamon (2007) suggests that the theoretical foundations of gravity
models are based on microeconomic theory, the new economic geography,
and trade theories. All these theories explain the existence of trade in differ-
ent views, and some of them lead to designs that resemble gravity models.
In the fundamental form of the gravity model, the volume of trade

exchange between two partner countries is assumed to increase proportion-
ally to their size, measured by national income (gross domestic product [GDP])
and reduce transportation costs proportionately between them, as measured
by the distance between their economic centers. In addition, gravity models
test the impact of various forms of distance. According to Laaser and Schrader
(2002), distances are measured not only as real geographical distances, but
also as virtual distances.4 Therefore, it is understandable that the empirical
results absolutely confirm the importance of distance in trade relations of
countries. Even the rapid decline in the costs of information and communica-
tion has not resulted in the death of distance (Ghemawat 2001). Several gravity
equations have been widely used to estimate the impact of a variety of politi-
cal issues, including regional trade groups, monetary unions, political blocs,
the activities of border regions, and historical ties (Djankov and Freund 2002;
Freund 1998; Soloaga and Winters 1999). Because of their comparative advan-
tages, habits, tastes, technology, and infrastructure, regions with borders and/
or a similar historical context can be natural trading partners.
The empirical results reveal a considerable number of studies that offer
either methodological advances or improvements or that attempt to explain
the impact of FTAs on trade flows. This article gives a systematic review of
recent research on the modeling of trade flows using an empirical standpoint
and provides a basis for assessing the present research.5 Furthermore, these
studies have expressed a strong interest in all aspects of the specification and
its application in gravity representation of trade flows including the effects of
FTAs. Nevertheless, Baier and Bergstrand (2007) observed that existing stud-
ies do not provide specific proof of positive results of these treaties to create
or diverse trade. For example, Endoh (1999) noted that the FTA in Latin
America (LAFTA) exposed trade creation or trade diversion trade with Japan.
However, Fukao, Okubo, and Stern (2003) have provided some evidence of
trade diversion as a result of NAFTA. Similarly, Soloaga and Winters (2001)
found only limited evidence of trade diversion due to the EU and European
FTA (EFTA). Thus, Robert (2004) investigated the potential of an FTA between
China and the association of Southeast Asian Nations (ASEAN). He concluded
that the creation of trade diversion is not expected. Eger (2004) indicated
that, although the FTA is not expected to have a short-term impact on trade
volumes, a considerable trade creation in the long term is expected; it
reported a rise in long-term 15% for NAFTA. An analysis of trade agreements
in African countries (Common Market for Eastern and Southern Africa
[COMESA]; Economic Community of Central African States [ECCAS]; and
Economic Community of West African States [ECOWAS]) was provided by
Musila (2005). The author finds no significant impact on the diversion and
creation of exchanges. In addition, similar conclusions were drawn for the
COMESA by Rojid (2006) and the AGADIR agreement by Péridy (2005) due
to the absence of trade complementarities between member countries.
In the same context, Tang (2005) examined the effects of FTA of NAFTA,
ASEAN, and Australia-New Zealand Closer Economic Relations agreement
(ANZCER). His results showed that trade among member countries has
increased; ANZCER FTA has led to a diversion of trade from non-members
FTA; and ASEAN has led to an increase in trade with non-members. Péridy
(2005) studied the effects of trade in the Euro-Mediterranean FTA (EMFTA); he
said that the FTA has led to an increase in exports from Mediterranean coun-
tries to the EU by 20% to 27%, indicating the creation trade. Carrere (2006)
found RTAs generating a substantial increase in trade among members, often
to the detriment of the rest of the world. Abedini and Péridy (2008) reported
a 20% rise in trade flows among regions belonging to the Grand Arab FTA
(GAFTA). Lee and Park (2007) proposed for new FTAs in East Asia, they noted
that trade facilitation would improve the creation of trade between FTA mem-
bers and reduce the diversion of trade between them. In addition, they indi-
cated that their proposed FTA would be beneficial compared to existing condi-
tions. Kalijaran (2007) reported that Australia should have more potential gains
in exports due to the Indian Ocean Rim Association for Regional Corporation
agreement. In a related development, Lakatos and Walmsley (2012) are inter-
ested in the FTA between ASEAN-China and their effects on the creation and
investment diversion. They have adopted the dynamic GTAP model to take
account of bilateral ownership of investment. Finally, Baier and Bergstrad
(2007) have attempted to clarify the effects of FTAs on trade, exploiting the
prevailing theoretical background of the gravity model and recent economet-
ric studies. Processing of FTAs as endogenous variables, subject interaction
effects concluded that the FTA affects considerably the trade.
DATA AND ECONOMETRIC MODEL
This study covers 27 Euro-Mediterranean countries, both developed and

developing countries, for the period 1980 to 2011. In this article, we will
consider in the first part a linear OLS. In the second part, we use panel esti-
mation techniques in order to better understand the impact of FTAs on the
country studied. This empirical work is part of studies trying to identify the
effects of FTAs on trade flows and economic relations in the Mediterranean
region (EU-15, EMU, AMU, and AGADIR agreement).The choice of these
countries can be explained by the fact that the group of developed countries
(EU-15) is considered the most advanced in terms of the integration process
(determined by the FTA). As well, the developing countries (the AMU and
AGADIR agreement countries member) tried to integrate into the international
economy and to take advantage of FTAs among the different members. We
estimated aggregate bilateral exports of 27 countries6 by using a panel data-
base with a maximum of 22,464 observations (27 × 26 × 32).
Our model aims to investigate the impact of the main variables of the
gravity model on trade flows. In the next step, we used dummy variables
EU-15, EMU, AMU, and AGADIR agreement in the gravity model to capture
the effect of these agreements on trade flow partners. In the same order, the
exports have the dependent variable in the model are explained by other
variables as defined by classical control theory, namely the level of economic
development determined by the GDP, the size of an economy is expressed
by the population, and so on. The main factor is the weight distance between
major trading nations.7 Otherwise, depending on the general gravity model
of trade, the volume of exports between country pairs EXPij is a function of
income (GDP), their populations, their geographical distance, and a set of
dummies, as indicated in the equation:
EXPij = α 0 GDPi α1 GDPjα2 POPi α3 POPjα 4 DISTijα5 Fijα 6 uij , (1)

where GDPi (GDPj) indicate the gross domestic product of the exporter
(importer), POPi (POPj) are the populations of the exporting country
(importer), DISTij measures the distance between the capitals of the two
countries, Fij represents all other factors that help trade between pairs of
countries, and uij is the error term.
To analyze the existence of groups of trade between the countries
involved in the process of FTA, dummy variables for the four clusters are
added to the gravity equation (Viner analysis). The choice of negotiating
groups is based on the geographical proximity of countries. The Mediterranean
region is formed by four economic integration agreements types of South-South
and North-North (UE-15, EMU, AMU, and AGADIR agreement). As a result,
the historical importance of trade links in the success of such a process was
an integrated FTA dummy variable for trade flows between countries sharing
a common language, a common border, and colonial links.
Thus, the basic specification to estimate the international trade flows of
the countries studied is as follows in first stage:
lnEXPijt = α 0 + α1 lnGDPit + α 2 lnGDPjt + α 3 lnPOPit + α 4 lnPOPjt

+ α 5 lnDIFGDPijt + α 6 lnSIML ijt + α 7 RER ijt + α 8 lnDISTij (2)
+ α 9 LANGij + α10 BORDij + α11COL ij + uijt .
In the same context, the second estimation is based in the following model,
which incorporates regional dummies:
lnEXPijt = α 0 + α1 lnGDPit + α 2 lnGDPjt + α 3 lnPOPit + α 4 lnPOPjt

+ α 5 lnDIFGDPijt + α 6 lnSIML ijt + α 7 RER ijt + α 8 lnDISTij + α 9 LANGij
+ α10 BORDij + α11COL ij + ∑ βr FTA*intra ijt + ∑ θ r FTA*EXPijt (3)
r r
+ ∑ ϕ r FTA*IMPijt ,
r
where ln indicates variables in logarithms, EXPijt are the exports from coun-
try i to country j in period t in current U.S. dollars. GDPit and GDPjt desig-
nates Gross Domestic Product of country i and j, respectively, in period t at
constant prices (US$). POPit and POPjt refers the population of countries i
and j, respectively, in period t. DISTij is the great circle distance between
countries i and j. DIFGDPijt determines the absolute value of the difference
of the GDP of countries i and j. SIMLijt is an indicator of the similarity of the
size of the GDP of countries i and j. This index takes values between 0 and
.5. For values close to zero, the two countries are considered very different
and very similar conversely for values close to .5 (Egger 2000; Dupuch 2001).
RERijt denotes the nominal exchange rate for each country vis-à-vis the dollar
(following Carrère 2006).
The proposed model reflects dummy variables for trading partners.

LANGij is dummy variable for business partners who share a common language,
and BORDij by sharing a common border. COLij the fact of seeing a colonial
relationship.
In the same context, the model includes dummy regional (table 1) to
determine the creation and diversion trade effects. FTA * intraijt test intra-area
trade whatever the regional group. It takes the value 1 if both countries i and
j have signed the same agreement, and 0 otherwise. FTA * EXPijt measure the
impact of consolidation on exports to the rest of the world. It takes the value
1 if the country i participates in an agreement without the country j is not a
member, and 0 otherwise. FTA * IMPijt captures the effects on imports from
the rest of the world. It takes the value 1 if i does not belong to the set to
which j participates, and 0 otherwise. Pursuant to the previous definition of
regional dummy, we present in table 1 the FTAs dummy variables in the
model estimated. Equations (2) and (3) are estimated as OLS and static
(Panel) for different years and for the period from 1980 to 2011, respectively.
For the OLS, estimated year by year were used. This refinement causes a
slight change in the estimation results with respect to the OLS.
In the equation (3), we introduced regional dummies variables to cap-
turing the levels of trade resulting from FTAs. If the set of dummies is prop-
erly inserted and the model is well specified, then the effects of the creation
TABLE 1 Definition of FTAs Dummy Variables in the Model Estimated
Country j
Dummies definition Inside region r Outside region r
Country i Inside region r FTA * Intraijr 1 0

FTA * EXPijr 0 1
FTA * IMPijr 0 0
Outside region r FTA * Intraijr 0 0
FTA * EXPijr 0 0
FTA * IMPijr 1 0
and trade diversion can be isolated. Creation and trade diversion in Viner are
specified by including three dummy variables for each FTA. The first has
traditionally been considered in the literature of the gravity model (proxy for
intra-regional trade), the second (exports from members to non-members),
and the third (imports members to non-members) were originally intended
as more dummies to capture extra-regional trade (Bayoumi and Eichengreen
1997; Frankel 1997; Frankel and Wei 1998). Soloaga and Winters (2001) and
Chen and Tsai (2008) also reported three separate sets of dummies. Our
specification of the Viner trade creation and diversion trade follows Carrère
(2006) and Martinez-Zarzoso, Nowack-Lehmann, and Horsewood (2009) is
given by:
lnEXPij = EVij + ∑ βr D r + ∑ θ r D ri + ∑ ϕ r D rj ,
r r r (4)
where EXPij are exports from country i to country j, EVij are the rest of explana-
tory variables, and Dr, Dri, and Drj, are dummy variables defined in the previ-
ous section as variables FTA * intraijt, FTA * EXPijt and FTA * IMPijt, respectively.
In a related development, βr measures the degree to which the trade is
higher than normal levels if both countries i and j are members of the bloc.
θr measures the degree to which exports its members are higher than normal
levels of non-member countries. ϕr measures the degree to which members
of imports are higher than normal levels of non-member countries. θr and ϕr
measure the effects of trade diversion, but they combine the effects of diver-
sion and trade openness.
Equation (4) isolates export diversion, import diversion, and openness
effect clarified of the increase in trade due to the RTA membership and is
therefore preferred (see Martinez-Zarzoso et al. 2009). The possible outcomes
following an FTA is indicated in table 2. For example, an expansion in
TABLE 2 The Interpretation of the Static Integration Effects
Intra-regional βr βr
Extra-regional Sign + −
Imports (ϕr) + Pure Extra-regional import
Trade creation in terms expansion
of import
− Trade creation + Import Import diversion + Intra-
diversion regional import
(βr > ϕr) contraction
Import diversion (βr < ϕr)
Exports (θr) + Pure Extra-regional export
Trade creation in terms expansion
of export
− Trade creation + Export Import diversion + Intra-
diversion (βr > θr) regional export
Export diversion (βr < θr) contraction
intra-regional exports (βr > 0) along with a greater propensity to import

(ϕr > 0) implies pure trade creation in terms of imports. In another sense, a
decline in intra-regional exports (βr < 0) conforms to a higher propensity of
import (ϕr < 0) involving the increase of extra-regional imports (imports from
the rest of the world increases. In the gravity regressions (Eqs.3), regional
dummies are used, holding into consideration the year in which the FTAs
were ratified and the year in which new countries formally signed the acces-
sion treaties.
In the same order, the using of panel estimation techniques allows
taking consideration of the specific temporal and transverse of this sample.
Kahouli and Kadhraoui (2012) signed that panel estimation with fixed effects
introduces several advantages, especially related to the inclusion of the
unobservable and stable characteristics over time. First, this technique

produces more variability, more degrees of freedom, and more efficiency
and minimizes the risk of multicollinearity between the explanatory vari-
ables. Second, it treats the problem of potential correlation between some
explanatory variables and the error term that does not vary over time. Third,
the fixed-effects model exploits the temporal dimension of data and allows
taking into account the dynamics of adjustment. Fourth, it controls heteroge-
neity by the inclusion of the invariant characteristics in time and/or space. In
the same context we use the Hausman test that allows choosing between the
specific fixed and random effects. The probability of the test in this work is
less than 10% (tables 3 and 4). The result of the Hausman test indicates that
in most of the regressions, fixed effects model is most relevant. Furthermore,
we use the Ramsey Reset test to test the omission of relevant explanatory
variable or model misspecification. The probability of the test is zero for all
estimates presented as follows in tables 3 and 4 (except for 1981); we can
reject the hypothesis at the 10% level (model has no omitted variables)
where the presence of omitted variables. Concerning the heteroscedasticity
test in cross-section data, it is used for testing the homoscedasticity of residu-
als. For panel data, it tests the significance of the random effects estimator.
In our case, the statistic probability of Breush-Pagan test shows that the
random effects are generally significant at the 1% level.
RESULTS AND IMPLICATIONS
The next development presents our econometric results and their interpreta-
tions and economic statistics. The results of the estimated model are shown
in tables 3 and 4. The tables in this section gives the results obtained with
OLS, panel fixed, and random effect with absence and presence of regional
dummies (table 4. As primary stage, and following the work of Baier and
Bergstrand (2007) and Martinez-Zarzoso and colleagues (2009), we esti-
mate cross-section gravity equations for multiple years. Table 3 shows the
TABLE 3 Yearly Estimates Results
Dependent variable: Exports
Independent variables 1981 1991 2001 2011
ln GDPt 1.380 1.387 1.297 1.333

(16.89)*** (19.82)*** (16.80)*** (11.92)***
ln GDPj 0.551 0.688 0.700 0.582
(7.97)*** (11.79)*** (12.38)*** (5.54)***
In POPi −0.360 −.332 −.289 −0.142
(−4.06)*** (−4.54)*** (−3.91)*** (−1.28)
In POPj 0.175 0.090 0.146 0.292
(2.31)** (1.50) (2.71)*** (2.73)***
ln DiPGDPij 0.113 −0.793 −1.248 −1.216
(0.27) (−1.81)* (−3.90)*** (−2.38)**

ln SIMLij −0.138 −0.095 −0.209 −0.109
(−2.19)** (−2.14)** (−4.15)*** (−1.88)*
ln RERij 0.0194 −0.007 0.021 −0.015
(0.45) (−0.36) (0.95) (−0.60)
ln Distij −1.164 −1.161 −1.041 −1.125
(−9.17)*** (−12.51)*** (−12.66)*** (−11.13)***
LANGij 0.433 1.063 0.829 0.841
(1.64) (5.32)*** (4.76)*** (3.48)***
BORDij −0.461 −0.460 −0.396 −0.234
(−1.23) (−1.82)* (−1.89)* (−0.88)
COLi 0.664 0.412 0.393 −0.118
(2.05)** (2.03)** (2.01)** (−0.37)
EU * Intraij −0.102 −0.035 0.167 0.090
(−0.74) (−0.31) (0.95) (0.56)
EU * EXPij 0.190 0.089 −0.246 0.423
(1.28) (0.71) (−1.51) (2.01)**
EU * IMPij 0.258 0.412 −0.066 −0.100
(1.33) (2.74)*** (−0.47) (−0.74)
EMU * Intraij 0.217 0.459
(1.51) (3.33)***
EMU * EXPij 0.152 0.044
(1.42) (0.31)
EMU * IMPij −0.108 −0.092
(−0.75) (−0.50)
AMU * Intraij 0.689 0.003 1.098
(1.26) (0.01) (3.25)***
AMU * EXPij −0.140 −0.396 −0.139
(−0.84) (−3.04)*** (−0.75)
AMU * IMPij 0.449 0.616 1.003
(1.67)* (2.56)** (3.40)***
Agadir * Intraij −0.287
(−0.62)
Agadir * EXPij −0.473
(−1.71)*
Agadir * IMPij −0.351
(−1.48)
Constant −20.144 −20.714 −20.259 −21.639
(−9.51)*** (−12.08)*** (−12.45)*** (−8.89)***
R2 0.733 0.831 0.838 0.850
N 602 625 584 496
(Continued)
TABLE 3 Continued
Independent variables 1981 1991 2001 2011
RMSE 1.531 1.190 1.114 1.101

Breusch-Pagan Test 0.000 0.000 0.000 0.000
Ramsey Reset Test 0.179 0.000 0.005 0.000
Note. The values in parentheses are t-statistics.

*Significant at 10% level; **significant at 5% level; *** significant at 1% level.
coefficient estimates of a log-linear gravity equation (equation [3] for a single

t-period) estimated based on nominal trade flows among 27 countries in
1981, 1991, 2001, and 2011. All variables enter with the provided signs,
which are statistically in most equations (2) and (3).
The first number denotes the coefficient assigned to the corresponding
explanatory variable (export flows. The number in parenthesis indicates the
significance test. It shows how much confidence we can say that this deter-
minant influences on trade flows. Adjusted R2, corresponding to the coeffi-
cient of multiple determination adjusted for the number of regressors, can
explain the variations of trade flows by changes of the regressors model.
The model coefficients in tables 3 and 4 are mostly highly significant at
less than 1%. This means there is a 99% chance that these determinants pro-
vide information on changes in export flows. R² is relatively strong for two
models with a slight decrease passing from OLS to static model. It means that
changes in export flows are explained (or dependent) more by changes in
explanatory variables. The elasticity of GDP of exporting and importing
countries is quite important for the year under review. It should be seen that
the influence of the GDP of countries exporting increases with time. And
increasing the size of the country affects trade flows, results consistent with
the expected results of gravity models. This is similar to the finding of
Martinez-Zarzoso and colleagues (2009) and Bussière, Fidrmuc, and Schnatz
(2008), who claim that there is a clear home market effect in export flow.
The population variable is included to show that the higher the coun-
try’s population, the greater its tendency toward self-sufficiency is important
and, therefore, less active engagement in trade. Alternatively, a large popula-
tion indicates a large domestic market and promotes division of labor, which
means that there are economies of scale in production and opportunities as
well as the desire to trade with a wider variety of products. The impact of
population cannot be specified a priori, since the effect can flow in a differ-
ent direction. This is also supported by Oguledo and MacPhee (1994) and
Augier, Gasiorec, and Li Tong (2005) that the effect of demographic variables
(for importing and exporting countries) on trade is indeterminate. The size
of the population can improve trade and inhibiting trade. On one side, a
large population can mean a significant allocation of resources, high degree
TABLE 4 Results of Panel Estimations

Explanatory
variables OLSa OLSb FEa FEb REa REb
ln GDPit 1.356 1.362 0.833 0.593 1.346 1.218

(140.91)*** (99.83)*** (5.31)*** (4.05)*** (22.20)*** (18.96)***
ln GDPjt 0.762 0.681 1.318 1.228 1.015 0.902
(94.47)*** (57.67)*** (9.96)*** (10.00)*** (18.25)*** (14.78)***
ln POPit −0.267 −0.294 1.354 1.825 −0.028 0.049
(−22.44)*** (−20.76)*** (4.04)*** (5.43)*** (−0.35) (0.67)
ln POPjt 0.076 0.123 −0.374 −0.286 −0.089 −0.019
(7.26)*** (10.13)*** (−1.57) (−1.15) (−1.29) (−0.31)
ln DifGDPijt −0.288 −0.416 0.127 0.213 0.322 0.347
(−4.27)*** (−5.80)*** (0.84) (1.40) (2.45)** (2.55)**

ln SIMLijt −0.119 −0.131 −0.213 −0.152 −0.119 −0.137
(−13.45)*** (−14.15)*** (−1.41) (−0.98) (−1.99)** (−2.26)**
ln RERijt 0.003 0.004 0.021 0.025 0.031 0.026
(0.68) (.0046569) (0.73) (0.84) (1.46) (1.24)
ln Distij −1.103 −1.103 −1.116 −1.118
(−63.19)*** (−62.11)*** (−12.89)*** (−12.97)***
LANGij 0.913 0.797 1.301 1.017
(24.10)*** (20.30)*** (8.25)*** (6.39)***
BORDij −0.395 −0.412 −0.655 −0.797
(−7.91)*** (−8.21)*** (−3.00)*** (−3.58)***
COLij 0.262 0.368 0.037 0.227
(5.59)*** (8.03)*** (0.15) (0.92)
EU * Intraijt 0.153 0.416 0.337
(6.21)*** (8.87)*** (7.91)***
EU * EXPijt 0.055 −0.024 −0.027
(2.04)** (−0.31) (−0.37)
EU * IMPijt 0.117 −0.028 0.024
(4.07)*** (−0.15) (0.16)
EMU * 0.424 0.290 0.303
Intraijt (16.32)*** (7.32)*** (7.94)***
EMU * EXPijt 0.070 −0.044 −0.058
(3.05)*** (−0.89) (−1.32)
EMU * IMPijt −0.099 −0.024 0.115
(−2.23)** (−0.30) (1.46)
AMU * 0.598 1.067 1.323
Intraijt (0.112)*** (2.34)** (2.91)***
AMU * −0.166 0.089 0.073
EXPijt (−5.01)*** (0.76) (0.61)
AMU * IMPijt 0.548 −0.471 −0.159
(9.25)*** (−2.52)** (−0.86)
Agadir * 1.012 0.322 0.500
Intraijt (11.44)*** (1.38) (2.18)**
Agadir * 0.247 0.141 0.175
EXPijt (3.75)*** (1.25) (1.50)
Agadir * 0.283 0.036 0.171
IMPijt (6.67)*** (0.40) (1.98)**
Constant −24.035 −22.403 −53.104 −53.881 −32.724 −29.105
(−86.09)*** (−68.36)*** (−11.45)*** (−10.13)*** (−16.86)*** (−14.04)***
R2 0.799 0.804 0.410 0.426 0.401 0.415
N 19042 19042 19042 19042 19042 19042
(Continued)
TABLE 4 Continued

Explanatory
variables OLSa OLSb FEa FEb REa REb
RMSE 1.297 1.281 0.873 0.898 0.5879 0.589
Hausman — — 0.000 0.000 0.000 0.000
Test
Breusch- 0.000 0.000 — — 0.000 0.000
Pagan
Test
Ramsey 0.000 0.000 — — — —
Reset
Test
Note. The values in parentheses are t-statistics.

a
Without regional variable.
b
With regional variable.
*Significant at 10% level; ** significant at 5% level; *** significant at 1% level.
of self-sufficiency, and less reliance on international trade. On the other side,

it is possible that the size of the market or population facilitates the division
of labor and creates more opportunities for the exchange of differentiated
goods, in which case, the coefficient of demographic variables can be posi-
tive. In our models, the population variable for exporting and importing
countries is sometimes positively and/or negatively significant and no signifi-
cant in other party.
In tables 3 and 4, for all columns the coefficients assigned to SIMIL are
negative and significant in most estimates. Countries with significant similar-
ity index trade more than countries with a lower index of similarity. The
significance attributed to the variable measuring the development gap is
weakly significant. Its negative coefficient is quite high especially for the OLS
estimates. As a result, the variable income gap is at a critical impact on exports
between the partner countries. The exception estimation with random effects,
column 5 and 6 (see table 4) where the development gap variable is positive
and significant at 5%. Given its high value, the development gap between
countries is thus largely affecting the flow of exports. Inter-industry trade
between countries seems to be strongly dominant. Distance has a strong
negative effect on the volume of trade between 27 countries. In other words,
most countries are distant from one another, and the less they trade. This
result corresponds to the classical results of gravity models. For the period
1980–2011, the removal of 1% between countries i and j leads to a decline in
exports averaged 1.1%. This decrease is almost constant for our model with or
without regional agreements. Variable common border negatively affects
trade contrary to classical results of gravity models. On the contrary the
coefficient of common language variable for the years studied are signifi-
cant and positive, indicating that the two countries sharing the same official
language common promote trade properly. On the dummy variable colony,

colonizer or colonized, each country has an advantage of exchange more
than other countries. As part of this work it is interesting to analyze the coef-
ficients of regional groupings in order to have an overview of the impact of
regional preference.
Dummy variables for membership in an FTA exhibit highly unstable and
unexpected results. For instance, the coefficient of the EU is almost still nega-
tive and insignificant signed in 4 years (see table 3), while the coefficients for
the EUX (exports to non-EU members) and EUM (imports from non-EU mem-
bers) are positive signed in several years and negative signed in others (1981
and 1991) without displaying a clear trend. Adding regional dummies in tables
3 and 4 improves the quality of the fit (greater R2 and smaller rmse), although
the results concerning regional dummies change little.

Passing in table 4 model without variable dummy with a regional dummy
model improves coefficient for OLS estimation (column 1 and 2) by increasing
coefficient of GDP. However, the estimation with fixed-effect model (columns
3 and 4) and random-effects model (column 5 and 6) with and without
regional variables reduces the coefficient of most variables (if not all).
We turn now to the results of model (3) of table 4 in the light of the
interpretative framework set out in table 2. In column 4 and 6, the coeffi-
cients of the variable intra-EU (15) are significant and positive. The intra-EU
dummy decreases from 0.416 to 0.337 passing a fixed-effect model to
random-effect model. The export-diversion (EU-EXP) and import diversion
(EU-IMP) effects change sign, from positive to negative and still insignificance.
The gravity model indicates a European specificity in international trade of
the Mediterranean area. The impact of this agreement in the direction of
trade flows to member countries is higher and significant. When two coun-
tries belong to this area, they are more likely to trade than all other countries
not belonging to this group. In the same context, the coefficient of intra-EMU
variable is positive and significant in tables 3 and 4 (see column 4 and 6),
which implies the promotion of exports between member countries of the
euro area where the creation of trade. The export-diversion (EMU-EXP) and
import diversion (EMU-IMP) effects change sign (−0.024 to 0.115), from posi-
tive to negative and still insignificance; this result is similar to that of EU
passing a fixed-effect model to random-effect model.
The FTA for the other two regions especially for southern Mediterranean
countries (AMU and AGADIR agreement) is less important; it is normal for
its effects to be felt in more recent times. The two FTAs have a positive and
significant coefficient for random-effect model; however, in the case of a
fixed-effect model, only intra-AMU is significant. Concerning the export
diversion (AMU-EXP), it is significant with a negative coefficient for the OLS
estimation, while for the fixed-effect model and random it is not significant.
This seems logical considering the low volume of trade between the member
countries of the AMU and specialization in the production of the same goods.
From columns 4 and 6, import diversion (AMU-IMP) has a negative and sig-
nificant sign for the fixed effect and insignificant for the random effect.
Regarding the AGADIR agreement: The export-diversion (AGADIR-EXP) and
import diversion (AGADIR-IMP) is in most cases to estimate the fixed effect
and random insignificant. However, the both coefficient are positive and
significant for the estimation with OLS.
In summary, for the regional groupings for EU-15, EMU, UMA, and
AGADIR agreement, two main observations can be made. First, the coeffi-
cients of the model are estimated in most cases positive and significant
(especially at the 1% level. In other words, this means that the two groups
have a positive impact on the direction of flow of exports. If the coefficients
of these variables are compared, it should be noted, in a second time, then
the EU-15 and EMU are higher. Thus, the fact of belonging to the EU-15 has
more influence on the direction of exports as belonging to the AGADIR
agreement or UMA, which makes logical economic sense.
CONCLUSION
The purpose of this research is to explore how and/or what the extent to
which FTAs affect trade flows of member countries by using a sample of 27
countries for the period 1980–2011. The proliferation of FTAs has attracted
much criticism, one of them being the fear of trade diversion from more
efficient non-member producers to less efficient producer members. FTAs as
lower trade barriers between the signatory, the expansion of bilateral trade
between its members could be at the expense of other non-members. Since
the mid-1990s, cross-gravity models and the inclusion of regional dummies
to test the importance of trade blocs have been criticized. For example,
Mátyás (1997) argues that gravity models (used OLS) testing the importance
of trade blocs are misspecified from an econometric point of view: The
parameter estimates corresponding to regional dummies may be biased. It
proposes the use of panel data and including the effects specific to each
country and time, using a dummy variable for each country of origin and
destination and the time. The study shows that there is an untapped poten-
tial for export to certain business partners in the study area. These results
have many policy implications for the trade strategy of Euro-Mediterranean
candidate countries. According to the empirical results, these countries
should move towards regional FTAs to increase trade flows, promote eco-
nomic growth (Kahouli and Kadhraoui 2012), and generate employment.
The implementation of FTAs involves not only the creation of the trade;
it also generates trade diversion. In the following, we present the recommen-
dations to help pass the FTA process and strengthen their own pace, given
the challenges, opportunities, and progress. First, the coherence in trade poli-
cies and FTAs is important to allow member countries to benefit more. Second,
trade reforms must be accompanied by other economic measures as a good

environment for macroeconomic policy, appropriate legislation, infrastruc-
ture, and well-developed institutions, and so on. Third, the plan of an FTA is
important in guiding this process. It should be reviewed, taking into account
the levels of development and current realities in different regions. Fourth,
diversification of the economy is necessary to minimize the impact of economic
shocks and to increase the benefits of trade reforms, which is not the case in
developing countries in our sample. Fifth, the FTA member countries should
implement industrial policies that would expand the industrial base in differ-
ent countries and improve the capacity to enhance competitiveness.
Finally, it should be noted that this work presents a modest contribution
that could be improved in several directions. The results obviously depend
on the methodology and data used. However, other estimation techniques

(the first-differenced GMM and the system GMM for the dynamic panel) may
allow better understanding of the importance of FTAs.
NOTES
1. This is an agreement between two or more countries or economies to form an FTA. An FTA is a
group of countries in which tariff and non-tariff barriers to trade among members are usually removed
but not with common commercial policy toward non-members.
2. The international trade flows are often seen as indicators of links between the economic centers
of the region, which shows the connections between economic and spatial units.
3. See Eichengreen and Irwin (1998), Feenstra (1998), and Estevadeordal, Frantz, and Taylor (2002)
for details.
4. They are expressed by trade barriers tariff or non-tariff barriers, different languages, differences in
business cultures, traditions, and economic systems.
5. See appendix table A1: summary of empirical works relating to effects of FTAs on trade flows.
6. The countries are listed in appendix table A2.
7. See appendix table A3: name and sources of the variables used.
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APPENDIX
TABLE A1 Summary of Empirical Works Relating to Effects of FTAs on Trade Flows
Dependent
Studies Countries Period variables Explanatory variables Estimation technique
Nitsch (2000) UE-12 1979–1990 Exports GDP, distance, common border, common OLS and fixed effects
language, remoteness of countries model
Egger (2002) OECD and 1986–1997 Exports GDP, GDP per capita, the similarity of the Fixed and random
10 countries of size of the country, the viability of effects models
Central-Eastern exporting and importing contracts, the rule
Europe of law of the exporter and the importer,
the real exchange rate, distance, common
border, common language
Glick and Rose 217 heterogeneous 1948–1997 Exports Union currency, distance, GDP, GDP per OLS, GLS fixed effects,
(2002) countries capita, common language, common border, GLS random effects,
FTA existence, a landlocked country, estimator between
number of islands, area, common colonizer,
256
current colony, ever colony, same nation.
Fukao et al. (2003) NAFTA 1992–1998 Imports GDP per capita, tariffs, total exports of OLS with fixed effects
goods, factors specific to each country
Baltagi, Egger, and EU-15, USA, Japan 1986–1997 Exports GDP, GDP per capita, the similarity in size of OLS with fixed effects
Pfaffermayr countries, distance
(2003)
Filippini and EU-11, USA, Japan, 1970–2000 Exports Increased exports, GDP, population, distance, OLS with fixed effects
Molini (2003) China, 6 countries technological differences, region
from Asia and 6
countries Latin
America
Egger (2004) OECD 1986–1997 Exports GDP, similarity, capital - labor ratio, high and Two-way fixed effects,
low ratio of skilled labor to transportation two-way random
costs, the viability of contracts exporter effects
and the importer, the law of the exporter
importer, accession to the EU, EFTA and
NAFTA
Augier et al. (2005) 38 countries (EU 1992–1995 Exports GDP, population, distance, membership in fixed effects
and partners) the EU, member of the EU, other countries,
common border, common language, the
impact of the accumulation
Martinez- Zarzoso The EU and five 1999 Imports and GDP, GDP per capita, the cost of transport OLS with fixed effects
and Suarez- Latin American Exports according to value ratio weight, distance,
Burguet (2005) countries volume of imports or exports, landlocked
country, language, transportation and port
infrastructure characteristics.
Péridy (2005) Méditerranéen 1975–2001 Exports GDP, GDP per capita, country similarity in OLS, fixed effects,
countries with 42 size, distance, type of border, regional random effects
partners arrangement between the EU and
Mediterranean countries, language
Lee and Park 50 Countries 1994–1999 Bilateral GDP, GDP per capita, distance, area OLS with fixed and
(2007) (Research on trade countries, common border, common random effects
regional trade language, common colonizers of a colony
agreements (past or present), participation in the
optimized for East monetary union, tariff, trade facilitation ,
257
Asia) belonging to the FTA
Bun and Klaasen EU-15, Norway, 1967–2002 Bilateral GDP, GDP per capita membership in the FTA, OLS with fixed effects,
(2007) Switzerland, trade integration of euro
Canada, Japan,
United States
Bussière et al. 61 countries (CSEEC 1980–2003 Bilateral Distance, territory, borders, language, free OLS, fixed effects,
(2008) and the euro trade trade arrangements: EU, NAFTA, random effects,
area) MERCOSUR, CEFTA, ASEAN dynamic OLS, fixed
effects with time
specific regional
effects
TABLE A2 Sample of Countries
Samples Countries
EU-15 Austria, Belgium, Luxembourg, France, Germany, Italy, Netherlands,
United Kingdom, Ireland, Finland, Denmark, Greece, Portugal,
Spain, and Sweden
EMU EU-15 + Turkey, Malta, Cyprus, Israel, Syria, Lebanon, Egypt, and
Jordan
AMU Tunisia, Algeria, Libya, and Morocco
AGADIR Agreement Tunisia, Morocco, Egypt, and Jordan
TABLE A3 Name and Sources of the Variables Used
Variables Definition Source

Dependent EXPij Export flows from country i to country j (or import from country i to country j) FMI (DOTS)
variable
Explanatory GDPi at GDPj Gross domestic product exporting (i) and importers (j) countries respectively. World Development
variables Indicators (2012)
POPi et POPj The population of the exporting (i) and importer (j) country respectively. World Development
Indicators (2012)
DIFGDPij The difference in economic development measured by the absolute value of the Calculation of author
difference of the GDP of countries i and j respectively:
GDPit GDPjt
DIFPIBH ijt = ln –
POPit POPjt
SIMLijt An indicator of the similarity of the size of the GDP of countries i and j. Calculation of author
GDPit GDPjt
SIML ijt = ln[1-( ) 2 -( )2 ]
GDPit +GDPjt GDPit +GDPjt
RERijt RERijt: The nominal exchange rate for each country vis-à-vis the dollar (NERi/s, the Calculation of author
259
value of the currency of country i $ 1) to extract data from IFS (IMF. CPIi is the
index of consumer prices in country i for each year from 1980 to 2011. The
bilateral real exchange rate (RER) is calculated as follows:
CPI jt
RERijt =( NERit /$ / NER jt /$ )
CPI it
DISTij Distance in kilometers between countries i and j (the flight distance between capitals. Chelem
BORDij Dummy for countries sharing common borders. Chelem
LANGij Dummy for countries sharing a common language. Chelem
COLij Dummy variable for countries with a colonial past. Chelem

FTA. EU15 Dummy variable taking the value one if the country is a member of the EU-15 and Calculation of author
zero otherwise.
FTA. EMU Dummy variable taking the value one if the country is a member of the EMU and Calculation of author
zero otherwise.
FTA. AMU Dummy variable taking the value one if the country is a member of the AMU and Calculation of author
zero otherwise.
FTA. AGADIR Dummy variable taking the value one if the country is a member of the AGADIR Calculation of author
Agreement and zero otherwise.

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Journal of East-West Business

ISSN: 1066-9868 (Print) 1528-6959 (Online) Journal homepage: http://www.tandfonline.com/loi/wjeb20

Regional Trade Agreements in Mediterranean

Bassem Kahouli & Samir Maktouf

To link to this article: http://dx.doi.org/10.1080/10669868.2013.794380

Published online: 04 Dec 2013.

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Regional Trade Agreements in Mediterranean

KEYWORDS FTA, gravity models, regional trade blocks

Union is a good example of North-North FTAs. The North-South FTAs involve

BRIEF LITERATURE REVIEW

In the fundamental form of the gravity model, the volume of trade

DATA AND ECONOMETRIC MODEL

This study covers 27 Euro-Mediterranean countries, both developed and

EXPij = α 0 GDPi α1 GDPjα2 POPi α3 POPjα 4 DISTijα5 Fijα 6 uij , (1)

lnEXPijt = α 0 + α1 lnGDPit + α 2 lnGDPjt + α 3 lnPOPit + α 4 lnPOPjt

lnEXPijt = α 0 + α1 lnGDPit + α 2 lnGDPjt + α 3 lnPOPit + α 4 lnPOPjt

The proposed model reflects dummy variables for trading partners.

TABLE 1 Definition of FTAs Dummy Variables in the Model Estimated

Dummies definition Inside region r Outside region r

Country i Inside region r FTA * Intraijr 1 0

TABLE 2 The Interpretation of the Static Integration Effects

intra-regional exports (βr > 0) along with a greater propensity to import

unobservable and stable characteristics over time. First, this technique

RESULTS AND IMPLICATIONS

TABLE 3 Yearly Estimates Results

Dependent variable: Exports

Independent variables 1981 1991 2001 2011

ln GDPt 1.380 1.387 1.297 1.333

(0.27) (−1.81)* (−3.90)*** (−2.38)**

Dependent variable: Exports

Independent variables 1981 1991 2001 2011

RMSE 1.531 1.190 1.114 1.101

Note. The values in parentheses are t-statistics.

coefficient estimates of a log-linear gravity equation (equation [3] for a single

TABLE 4 Results of Panel Estimations

Dependent variable: Exports

ln GDPit 1.356 1.362 0.833 0.593 1.346 1.218

(−4.27)*** (−5.80)*** (0.84) (1.40) (2.45)** (2.55)**

Dependent variable: Exports

Note. The values in parentheses are t-statistics.

of self-sufficiency, and less reliance on international trade. On the other side,

language common promote trade properly. On the dummy variable colony,

the results concerning regional dummies change little.

trade reforms must be accompanied by other economic measures as a good

on the methodology and data used. However, other estimation techniques

Baier, S. L., J. H. Bergstrand, P. Egger, and P. McLaughlin. 2008. Do economic integra-

Bergstrand, J. H. 1989. The generalised gravity equation, monopolistic competition,

DC: Institute for International Economics.

Mátyás, L. 1997. Proper econometric specification of the gravity model. World

Weltwirtschaftlishes Archiv 90:91–113.

TABLE A2 Sample of Countries

TABLE A3 Name and Sources of the Variables Used

Variables Definition Source

COLij Dummy variable for countries with a colonial past. Chelem

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(0.27) (−1.81)* (−3.90)* (−2.38)

(−4.27)* (−5.80)* (0.84) (1.40) (2.45) (2.55)