Australia's global trade potential: evidence from the gravity model analysis.

• Author: Rahman, Mohammad Mafizur
• Position: Report - Statistical data

1. INTRODUCTION

   The foreign trade sector of Australia constitutes an important part of its economy. The trade-GDP ratio increased to 42.09 percent in 2006 from 32.90 percent in 1980. However, despite the gradual importance, this sector has been suffering from a deficit over the period of 1980-2007 with the only exception of 1991 when this sector experienced a slight trade surplus (WDI, World Bank). Furthermore, the growth rate in the volume of Australian merchandise export trade is also lower compared to other countries. In 2006 and 2007, the growth rates were 2.0 percent and 2.5 percent, respectively. These figures were 10.5 percent and 7.0 percent for the USA, 22.0 percent and 19.5 percent for China, 11.0 percent and 11.5 percent for India, 10.0 percent and 9.0 percent for Japan, 13.5 percent and 11.5 percent for Asia, and 8.5 percent and 6.0 percent for the world (WTO 2008).

   In addition, Australia's share in world exports, imports and trade is still very low and unimpressive when compared with other countries including its Asian neighbours. In 2007, Australia's export, import and trade share in world trade was 1.0 percent, 1.2 percent and 1.1 percent, respectively. These figures were 9.5 percent, 7.4 percent and 8.5 percent for Germany, 8.7 percent, 6.7 percent and 7.7 percent for China, 8.3 percent, 14.2 percent and 11.3 percent for the USA, 5.1 percent, 4.4 percent and 4.7 percent for Japan, 2.7 percent, 2.5 percent and 2.6 percent for the Republic of Korea, 2.1 percent, 1.8 percent and 2.0 percent for Singapore, and 1.3 percent, 1.0 percent and 1.2 percent for Malaysia (IMF 2007). Therefore, Australia must increase its trade volume with the rest of the world for the sake of healthy economy. Hence this study--an estimation of Australia's trade potential--is crucial and justified.

   In the process of estimation of Australia's trade potential, we have used the generalised gravity model. This model is a widely used empirical tool for analysing bilateral trade flows. We have used the gravity model to first analyse the Australia's trade flows globally for the year 2001 and 2005. The coefficients thus obtained from the estimated gravity models are then used to predict Australia's trade potential.

   The main contribution of this study is as follows: To the best of my knowledge, this is the first study that has estimated Australia's global trade potential using the gravity model extensively against the backdrop of Australia's historic trade deficit and lower and unimpressive share in the world trade. The study covers 97 percent of Australia's global trade. Thus this study will play a significant role for policy makers in particular, and for the economies of Australia and its trading partners in general.

2. THE GRAVITY MODEL OF TRADE

   The gravity model of trade states that trade flow between two countries is positively proportional to the product of each country's GDP (national income) and inversely proportional to the distance between the countries. This formulation can be generalized to

   [Trade.sub.ij] = [alpha] [Y.sub.i][Y.sub.j]/[D.sub.ij] (1)

   where [Trade.sub.ij] is the value of the bilateral trade between country i and j , [Y.sub.i] and [Y.sub.j] are country i's and country j's GDPs, [D.sub.ij] is the geographical distance between the countries' capitals and [alpha] is a constant of proportionality.

   Taking logarithms of the equation (1), we get the following linear form of the model:

   Log([Trade.sub.ij]) = [alpha] + [beta] log (YiYj) + [delta] log ([D.sub.ij]) (2)

   Where [alpha], [beta] and [delta] are coefficients to be estimated. Equation (2) is the baseline model. However, we know that there are other factors that influence trade levels.

   Most estimates of gravity models add a certain number of dummy variables to (2) that test for specific effects, for example being a member of a trade agreement, sharing a common land border, speaking the same language and so on.

   Assuming that we wish to test for p distinct effects, the model then becomes:

   [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII] (3)

3. LITERATURE SURVEY

   There are wide ranges of applied research where the gravity model is used to examine the bilateral trade patterns and trade relationships (see Bergstrand 1985 and 1989, Oguledo and Macphee 1994, Frankel 1997, Karemera et al. 1999, Mathur 1999, Sharma and Chua 2000, Rahman 2003, Batra 2006 for example). These studies use the gravity model both for the aggregate bilateral trade and also for product level trade. Both the cross -section and panel data approaches have been used by these studies.

   Many of these works also try to examine the trade potential, trade determinants, trade direction and trade enhancing impacts. For example, Rahman (2003) examines the determinants Bangladesh trade using panel data estimation technique and generalised gravity model. The author considers both economic and natural factors when estimating the gravity model. The study covers data of 35 countries for 28 years (1972-99). Batra (2006) considers the augmented gravity model to estimate India's trade potential. The model is based on cross-section data of 2000. Hassan (2000, 2001 and 2002) examines the effects of regional trade blocks on bilateral trade of 27 countries using crosssection data. Taking cross- section data from 1996-99 and using ordinary least square (OLS), Christie (2002) analyses trade potential for Southeast Europe. In a sample of 76 countries, Kalbasi (2001) examines the volume and direction of trade for Iran dividing the countries into developing and industrial countries. The impact of the stage of development on bilateral trade is analysed in this study. Using cross-section and panel data Frankel (1997) also applies the gravity model to examine roles of trading blocs, currency links, etc. Analysing the bilateral trade patterns worldwide Frankel and Wei (1993) examine the impact of currency blocs and exchange rate stability on trade. Anderson and Wincoop (2003), Baier and Bergstrand (2003), and Feenstra (2003) analyse the impact of multilateral factors on bilateral trade flows.

4. DATA, METHODOLOGY AND MODEL SELECTION, ESTIMATION, AND ECONOMETRIC ISSUES

   4.1 Data and Sample Size

   Our study covers Australia's trade with 49 countries around the globe. In 2005, Australia's trade with these countries together comprises 96.77 percent of its total world trade. For 2001 data, these trade statistics are also, more or less, similar. The countries are chosen on the basis of importance of trading partnership with Australia and availability of required data. Twenty countries from Asia, eighteen countries from Europe, three countries from North America, three countries from South America, two countries from Africa and three countries from Australasia are included in the sample as Australia's trading partners.

   The data are collected for the period of 2001 and 2005. All...