Gravity Model Application: Analyzing Vietnam's Bilateral Trade Flows

This report applies the Gravity Model to analyze bilateral trade flows of Vietnam and other countries in 2015. The introduction explains the model's use in international trade and its ability to explain trade volumes based on gravitational force concepts. The report investigates the impact of factors such as economic size, geographical distance, and culture on trade flows. The literature review covers the model's empirical analysis, theoretical foundations, and application in international relations. The model description includes the equation and its application by Tinbergen, highlighting the positive effect of GDP and proximity on trade. The analysis section demonstrates the use of the Gravity Model and diagnostic tests, while the conclusion summarizes the key findings and limitations. The study found that factors like foreign market size, distance, and economic size significantly influence bilateral trade between Vietnam and its partners. The report also acknowledges the limitations of the study, such as the data constraints.

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GRAVITY MODEL
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Introduction
The report applies Gravity Model for the purpose of analyzing bilateral trade of other
countries and Vietnam of 2015. The model is a popular econometric model in international trade.
The model came from its use of gravitational force concept as a method of explaining volume of
joint trade flows between different countries. In my report I embark on the use of data on
international trade of Vietnam and other countries. The approximate results revel that distance
and culture, economic size of foreign partners, economic size of Vietnam largely affected
bilateral trade flows between other countries and Vietnam. The report also included the use of
varied variables, assumptions of their influences to Vietnam as a country, difficulties of gravity
equations and their actual resolving. Gravity model is a practical success because it precisely
foretells trade flows of Vietnam and other countries for many goods and services. Nevertheless,
gravity correlation can ascend in nearly all the trade model and it consists of trade costs which
arise as the distance increases. The question always arises in regard of what factors influences
the selection of foreign trade partners of Vietnam for the purposes of exploiting the comparative
importance of each country. Gross Domestic Product (GDP), geographical distance, the actual
population greatly influence trade flows between different countries like Singapore and
Montanari. The first section states the literature review on the model and the advantages on the
international trade. The second part describes and illustrates the actual meaning of gravity model
and the definition of various variables used. The third section demonstrates the analysis used in
order for the purposes of explaining the bilateral trade. The final part is the actual conclusion.
Literature Review
The model is mostly used more often to empirically analyze trade between countries. It
has been described as the workhorse of trade that involved different countries and its ability to
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correctly estimate bilateral trade flow. In the recent past years there has been abnormal change
and progress both in improving its empirical estimation and understanding theoretical basis for
the entire equation. The name gravity model comes from its use of gravitational force concept as
a method of explaining the volume of bilateral trade flows. At first, it was only based on
theoretical intuition, but later on, different theoretical foundation has been invented. Newton’s
law of gravity promoted the original gravity model of economic interaction over the space.
The gravity model continues to be successful as it correctly predicts the actual trade flows
between countries for different goods and services. It uses to estimate the pattern of international
trade. The model basic form is made up of elements that are largely concerned of spatiality and
geography, gravity model are mostly being used to check rooted on hypotheses purely in
economic theories of trade. Such theories suggest that trade will be built on relatively factor
abundances. Countries with plenty of one factor would then produce goods which requires
relatively big amount of factors in their real production. The gravity model of trade has also been
used in the area of international relations in order to determine the effect of treaties and alliances
on trade activities. The model analyzes the effectiveness and efficiency of foreign trade
agreements. (Prehn, Brümmer and Glauben 2016).
Lately, gravity model mostly describe bilateral the flows of trade between different
countries that cannot be explained by other economic theories. Factors such as infrastructure,
exchange rates and income differences are included to the standard gravity equation, are found to
be most significant determinant of bilateral trade flows (Nowak-Lehmann and Martinez-Zarzoso
2004). The Vietnam bilateral trade is mostly affected by economic size, openness and common
language, GDP per capita, and negatively by the actual area between the trading partners.
Model Description
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The model is mainly being use to ensure the smooth flows of trade between two countries
that are unable to be solved via other economic theories. Based on the law of gravitation, the G
between two matters remains proportional of their respective masses and universally connected
to square of respective distance.
(i) The equation of the model is given as follows:
Where;
(ii) The gravity model can also be described by the equation below:
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The model was first applied by Timbergen to analyze foreign trade flows in the year
1962. In such a model, whereas trade flow between country A and B stood as the dependent
variable, geographical distance and GDP remained the independent. Where this model is used,
the eventual result indicates that as unlike distance, GDP variable shows a positive effect on
trade flow between A and B. This implies that an economy with larger economic size as well as
closer distance has a tendency of trading with one another more (Baier and Bergstrand 2009).
The model has been used is the analysis of predicted trade flows alongside observing
differences between predicted as well as observed flows (residual analysis). This is basically
analysis of trade potentials of economies of transitions also called out-of sample predictions;
identification of natural markets as well as markets with the untapped potentials of trade. It is
also mainly used in the analysis of the predicted values utilized in some instances as the input for
CGE modeling. Residual variance has been considered via the use of confidence intervals
alongside predicted values.
Analysis of result
The diagnostic test is used to illustrate the assumption of random effects model. Final
illustration states that there are heteroscedasticity and multicollinearity. Multicollinearity can be
described by high association of Vietnam’s population and Vietnam’s GDP. If we employ the
use of a large data in the study, then the actual effect of multicolinearity on the result can be
controlled. The table below estimate results using the above equation of gravity model after
resolving defects.
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The variables which has an effect on Vietnam’s bilateral trade are: foreign market size
(Nj),distance(Dij), exchange rate(EXiJ), Economic size of both Vietnam and partner
country(Yi,Yj) and culture(Cij).
The growth of GDP of partners and Vietnam help in increasing the total trade value. An
increase of 1% in foreign partner’s GDP will improve trade value by roughly 0.8% (Baltagi,
Egger and Erhardt 2017).
Conclusion
The main purpose of the report is for the determination of factors that influence bilateral
trade flows between partners countries and Vietnam around the world; and then establishing
variables that is used. The model was estimated with data derived from different countries in the
the year of 2015. The result obtained indicated that bilateral trade flows between partners
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countries and Vietnam are mostly affected by the foreign market size, geographical distance,
national culture and economic size.
The actual progress in foreign partners and economic size of Vietnam has a good impact
on the movement of bilateral trade. The limitation of the study is that it is only limited in the data
when some areas has not been identify and included in the research.
References
Baier, S.L. and Bergstrand, J.H., 2009. Bonus vetus OLS: A simple method for approximating
international trade-cost effects using the gravity equation. Journal of International
Economics, 77(1), pp.77-85.
Baltagi, B.H., Egger, P.H. and Erhardt, K., 2017. The estimation of gravity models in
international trade. In The Econometrics of Multi-dimensional Panels (pp. 323-348). Springer,
Cham.
Bergstrand, J.H., 1985. The gravity equation in international trade: some microeconomic
foundations and empirical evidence. The review of economics and statistics, pp.474-481.
Çekyay, B., Palut, P.T., Kabak, Ö., Ülengin, F., Özaydın, Ö. and Ülengin, B., 2017. Analysis of
the impact of bilateral and transit quotas on Turkey's international trade by road transport: An
integrated maximum flow and gravity model approach. Research in Transportation Economics.
Egger, P., 2002. An econometric view on the estimation of gravity models and the calculation of
trade potentials. The World Economy, 25(2), pp.297-312.
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Mansfield, E.D. and Reinhardt, E., 2015. International institutions and the volatility of
international trade. In THE POLITICAL ECONOMY OF INTERNATIONAL TRADE (pp. 65-96).
Martí, L. and Puertas, R., 2017. The importance of export logistics and trade costs in emerging
economies. Maritime Economics & Logistics, 19(2), pp.315-333.
Mathur, S.K., Arora, R. and Singh, S. eds., 2018. Theorizing International Trade: An Indian
Perspective. Springer.
Patuelli, R., Linders, G.J., Metulini, R. and Griffith, D.A., 2015. The space of gravity: Spatial
filtering estimation of a gravity model for bilateral trade.
Prehn, S., Brümmer, B. and Glauben, T., 2016. Gravity model estimation: fixed effects vs.
random intercept Poisson pseudo-maximum likelihood. Applied Economics Letters, 23(11),
pp.761-764.
http://www.piie.com/publications/chapters_ preview/72/4iie2024.pdf
World Integrated Trade Solution. Retrieved from:
http://wits.worldbank.org/CountryProfile/en/Country/CZE/Year/2014/TradeFlow/Import
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