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Gravity Model of Trade
Since the very beginning of the history of human kind people united in communities, which formed towns, cities and countries. Country and city territories were clearly defined and carefully guarded. Neighboring countries were establishing trading unions and partnerships, which allowed the countries to develop and ensure their prosperity. Although throughout times the country borders have changed, over the past decades a new trend began to form in the world. Globalization and unification has led to the creation of greater trading unions and intra-state formations. Unions with economy as their basis have become political and cultural larger communities with supranational institutions, such as the EU. This research reviews the implementation of the gravity model of trade in two countries that have established close economic relationships and are important trading partners for each other.
Gravity Model of Trade Description
The gravity model of trade is the model of interaction between spatial objects (cities, regions, countries) in the regional analysis and spatial analysis of economy. In different versions this model is used in the study of urbanization, industry allocation, export-import relationships, and population migration. The common feature of these model modifications is that the interaction force (flow rate) depends on the importance (value) of the objects and the distance between them. It is easy to see that this formula is similar to the formula of physical attraction between bodies. These models are applied to the study of trade flows between pairs of countries. They take into account socio-economic factors; export opportunities and import requirements of trading partners are determined; factors relating to the promotion of commodity flow (distance, availability of customs barriers, etc.) are defined.
Up until recent times, gravity models of trade have been considered very successful and trustworthy. One of the articles analyzed in this research (National Borders Matter: Canada US Regional Trade Patterns) is based on the assumption of Alan Deardoff that despite somewhat dubious heritage, gravity models have been extremely successful empirically (cited in McCallum, 1995, p. 615). Therefore, this is an example of an interesting theory that does not have a strong theoretical background, but somehow have strong proofs on practice. At the same time, the second article argues that sometimes the Gravity Model does not always have strong empirical proof, while at the same time try to find the theoretical background for the model.
US and Canada Trading Relationship
Canada and the United States are countries with not only similar culture and history, but have also established a very strong business connection. Currently they are the main business partners for each other and the largest trading partners for each other. The United States and Canada have established a vital economic partnership, which is carefully guarded and protected by both countries. This relationship is so significant for both states that the question of free trade has been on the agenda in both the US and Canada for centuries and was supported by trade agreements throughout time. The North American Free Trade Agreement (NAFTA) has established the final regulations for free trade between the United States, Canada, and Mexico the three countries located in North America. NAFTA shows how important are the business relationships between the United States and Canada.
The two articles studied in this research analyze the gravity model of trade, although they view it from different angles. Along with the main trade model, the subject of their study the United States and Canada, also unites the articles. The two researches emphasize the importance of business cooperation between the two countries, thus try to analyze the patterns of economic cooperation of the United States and Canada.
John McCallum (1995) focuses on the role of borders between Canada and the United States. Although the countries have relatively open trading relationship, the author states that national boundaries still play a significant role in the patterns of the economic life of cities and whole regions. By using the Gravity Model McCallum (1995) shows how the relationships between countries should exist without any border limitations, and how they exist in real world.
In order to prove the hypothesis, McCallum (1995) uses the study of imports and exports for the 10 provinces of Canada and 50 states of the United States that are analyzed in the research. The author also defines trade flows that would be predicted in the two borderless countries in comparison with the actual data. McCallum (1995) defines that in the two states without borders trade would be allocated in a totally different way and presents a number of examples. For example, judging from the geographical closeness Quebec should export to California 10 times more than to British Columbia, as Californias GDP is more than 10 times higher than the one of British Columbia. In fact, the exports of Quebec to California are three times less than the ones to British Columbia (McCallum, 1995, p. 617). By presenting a number of similar examples the author concludes that national borders still play a significant role even in countries with free trade.
Anderson and Wincoop (2003) approach the Gravity Model in a totally different way. The authors take this model of trade and the subject of the study and prove that it still requires theoretical background and are trying to find it. The authors are reviewing the McCallums article, which became one of the strongest background works for the Gravity Model and are trying to solve the border puzzle created by McCallum. After conducting a thorough research Anderson and Wincoop (2003) have concluded that although in practice the Gravity Model easily fits with data and statistical information, it in fact does not still have any proven theoretical background. The lack of theoretical background in the theory leads to biased estimation, incorrect comparative statistics analysis, and generally a lack of understanding of what is driving the results (Anderson and Wincoop, 2003, p. 188). All in all the article emphasizes the fact that in order to fit data to the Gravity Model one has to generalize data and avoid variables, just as McCallum (1995) did in his work.
Although the two authors have tried to solve the border puzzle, they havent reached full success due to the limitations that exist within the Gravity Model. Still, Anderson and Wincoop (2003) have to some extend proven the thesis of McCallum and supported the idea that borders slow the trade between countries. What is interesting, Anderson and Wincoop (2003) have also made an emphasis on the difference between international and intranational trade, which corresponds to the new needs and theories of the 21st century.
Gravity Model of Trade is one of the most popular models used for the study of economical relations between countries. With the changing role of borders between independent states and introduction of supranantional unions (such as the EU or NAFTA) the role of borders is changed. The two articles analyzed in this research study the changing role of borders from the point of view of Gravity Model. While McCallum (1995) was among those making the first steps in the study of the role of borders in the cooperation of countries with free trade agreements, ten years later Anderson and Wincoop (2003) have based their research on McCallums work.
While McCallum used the Gravity Model primarily as a tool to prove and justify his theories and conclusions that borders still play a significant role for countries with free trade relationships, Anderson and Wincoop went even further. Grounding their work on McCallums research, the two authors have tried to provide stronger theoretical background for the Gravity Model. It is a common knowledge that despite being very useful in practical life, this model does not have a sufficient theoretical background, which consequently leads to a number of limitations. Although Anderson and Wincoop have managed to support the thesis that borders still play a great role in international and intranational trade, they still were not able to give a solid theoretical background for the gravity equation.