SIMULATIONS MODELS FOR INTERNATIONAL TRADE
GRAVITY EQUATIONS FOR INTERNATIONAL TRADE MODELS
Paris-Dauphine / September 2015
DOCUMENT 3:
Assignment: Simulation Exercise for the effects of NAFTA on trade 1
Ramón Mahía – UAM
(Based on the material provided y UNCTAD-WTO)2
1.- BACKGROUND
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NAFTA was conceived as a regional trilateral trade agreement signed in 1994 by Canada, Mexico, and the
United States
The basic idea is to use a gravity model to empirically test the effects of NAFTA agreement in terms of trade
creation (total trade increase as a result of FTA) and/or trade diversion (trade reallocate from non FTA
members to FTA members). Suppose that countries “i” and “j” belong to a common FTA, whereas country
“k” does not. If, after the FTA’s formation, “i” imports more from “j” and less from “k”, trade diversion is
likely. If, in contrast, country “i” imports more from “j” and from “k”, trade creation is likely” (see Box 3.1
page 109 of WTO Manual to understand how to empirically test trade creation and trade diversion).
The basic idea is to complete the exercise that you can find in WTO Manual, Chapter 3, page 131, sections
2, 3 and 4. Instructions are very clear in the text and also a do.file is also provided by WTO in case you need
to explore and work some extra details.
The MINIMUM work to do is to go through the following instructions and make some comments on the
basic econometrical results obtained.
EXTRA POINTS will be obtained for extra work such as:
o Add some preliminary graphs or descriptive analysis (before econometrical estimation)
o Enrich econometrical exercise:
 Using of additional explanatory variables as covariates
 Testing the variation of NAFTA effect along the time
 Trying alternative estimation / specification strategies (for example using random effects
or alternative ways of addressing MRT’s issue without a panel)
Preliminary steps:
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We don’t need to build up the data file according to section 1 (Preliminaries). The file is already
prepared as agGravityData.dta.
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A regional trilateral trade agreement signed by Canada, Mexico, and the United States, that came into force on January 1, 1994.
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IMPORTANT NOTE: The content of this document, and specially the exercise section, is based on the document prepared by
UNCTAD-WTO entitled “A Practical Guide to Trade Policy Analysis. (Chapter 3. Analyzing bilateral trade using the gravity equation). To
access the on-line version of this UNCTAD-WTO doc, visit the WEB page: http://vi.unctad.org/tpa/index.html
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This file agGravityData.dta contains information enough to build a gravitational model including
trade flows and some other basic info for around 80 countries and for the period 1982-2004.
use "C:\Users\RAMON\Desktop\GRAVITY\Practical guide to TPA\Chapter3\Datasets\agGravityData.dta", clear
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Nevertheless, a thing to do is to create four NAFTA dummies in order to test NAFTA impact on trade:
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One dummy to simply identify NAFTA members “nafta” (from year 1994 )
A Second one to identify intra-NAFTA bilateral trade “intra_nafta” (observations with import and
export country being NAFTA members) (from year 1994 )
A third one “imp_nafta_rest” to identify import trade to a NAFTA from a NON-NAFTA member
(from year 1994 )
A fourth one “exp_nafta_rest” to identify exports from a NAFTA member to a NON-NAFTA
member (from year 1994 )
o
gen nafta = (ccode=="CAN" | ccode=="MEX" | ccode=="USA")
label var nafta "1 if home is nafta member"
gen pnafta = (pcode=="CAN" | pcode=="MEX" | pcode=="USA")
label var pnafta "1 if partner is nafta member"
gen intra_nafta = (ccode=="CAN" | ccode=="MEX" | ccode=="USA") & (pcode=="CAN" | pcode=="MEX" |
pcode=="USA")
replace intra_nafta = 0 if year < 1994
label var intra_nafta "1 if trade bewteen nafta members"
gen imp_nafta_rest = (ccode=="CAN" | ccode=="MEX" | ccode=="USA") & (pcode!="CAN" & pcode!="MEX" &
pcode!="USA")
replace imp_nafta_rest = 0 if year < 1994
label var imp_nafta_rest "1 if nafta's imports from the rest of the world"
gen exp_nafta_rest = (pcode=="CAN" | pcode=="MEX" | pcode=="USA") & (ccode!="CAN" & ccode!="MEX" &
ccode!="USA")
replace exp_nafta_rest = 0 if year < 1994
label var exp_nafta_rest "1 if nafta's exports to the rest of the world"
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Econometric estimations:
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We start by declaring the panel structure (and generate some logarithms)
egen id = group(ccode pcode)
tsset id year
gen lnV = log(imp_tv)
label var lnV "value of imported goods in logarithm"
gen lncGDP = log(cgdp_current)
label var lncGDP "partner's current GDP in logarithm"
gen lnpGDP = log(pgdp_current)
label var lnpGDP "home's current GDP in logarithm"
gen lnD = log(km)
label var lnD "bilateral distance in logarithm"
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We will then estimate a first fixed effects panel gravity equation for logarithms of value of imports (lnV)
including logs of GDPs, distance, NAFTA trade creation and trade diversion dummies (“intra_nafta” and
“imp_nafta_rest”) and year dummies. The interpretation of both coefficients might be used as an empirical
test about trade creation and/or trade diversion
xtreg lnV lncGDP lnpGDP lnD intra_nafta imp_nafta_rest exp_nafta_rest i.year*, fe robust
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