Kengoay. Pdf

j

k

j

k

i

k

w

i

w

i

k

i

ij

M

M

M

M

M

M

X

X

COM

 

 

where 

k

i

X

 is country  i’s exports (of commodity  k), 

k

j

M  is country  j’s imports (of 

commodity  k) and 

k

w

M

 is world imports (of commodity  k).  COM

ij

 is able to 

separate the impact of the commodity composition from other factors that drive trade 

flows and represents the extent of the fit between the structure of exports and imports 

of bilateral trade partners based on the assumption that traded commodities reflect 

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14

factor endowments.

16

  The index is calculated at the three-digit level of the Standard 

Internationa l Trade Classifications (SITC).

17

 

 

A second methodological issue concerns the definition and measurement of trade 

creation and trade diversion where a gravity approach is seen as a more elaborate 

method of measurement (Hine 1994).

18

  Aitken (1973) was one of the first studies to 

attempt to capture trade creation and trade diversion by the inclusion of a regional 

dummy with additional calculations for the counterfactual residual to capture the trade 

diversion and the net trade creation in a Vinerian sense.  Elbadawi  (1997), Bayoumi 

and Eichengreen (1997), Frankel (1997), Frankel and Wei (1998) introduced a second 

dummy to show the regional integration effect on the trade with non- members as well 

as an intra-bloc dummy.  The first two studies, however, do not separate the 

diversionary effect of imports and exports, while Frankel and Wei (1998) ignore the 

possible effect of regional integration on exports to non- members (Soloaga and 

                                                 

16

 Drysdale (1967) attempted to explain the causes of bilateral trade by dividing trade 

intensity (I) into complementarity (C) and bias (B) where  I = C 

×

 B.  Complementarity is 

a product of comparative advantage if we assume that import and export patterns reflect 

their resource endowment and represents the extent to which economies resources and 

production structures are complementary while bias is what remains after accounting for 

complementarity and includes geographical, social, historical, cultural and institutional 

ties. 

17

  A number of studies argue that the three-digit SITC level captures commodities that 

are produced using a similar technology and factors (see e.g. Greenaway and Milner 1986, 

and Menon 1996). 

18

  Viner (1950) first referred to trade creation and trade diversion in the context of the 

welfare effects of trade barriers.  Early approaches however, tended to compare actual 

import value data for a post regional integration period with counterfactual import values 

estimated by using only pre-integration data.  For example, Truman (1969) assumed the 

pre-integration  shares  of  imports  in apparent consumption to  be  unchanged,  whilst 

Balassa (1967, 1974, 1975) assumed that the pre-integration import elasticity would have 

continued in the post-integration period.  Truman interpreted the increase in import 

share, compared to the antimode to mean trade creation and the decrease in the rest of the 

world share to mean trade diversion, while Balassa argued that increased intra-elasticity 

was gross trade creation, increased elasticity from all sources was trade creation and 

decreased elasticity from non-area sources was trade diversion.  Kruger (1999) examined 

NAFTA’s trade creation and trade diversion effects using industry level data.  Other 

approaches include Verdoorn and Schwartz (1972) who incorporated relative prices into 

the model and Prewo (1974) who combined input-output tables and the gravity model as a 

general equilibrium approach 

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15

Winters, 2001).  We follow Endoh (1999, 2000) and pursue the relatively new 

approach of employing three dummies per region.

19

 

 

Including dummies for what we define as “import trade diversion” and “export trade 

diversion” enables us to tell whether an increase in an institutional dummy is due to 

an increase in intra-regional trade, a decrease in trade between members and 

non- members, or both.  In our estimates  “RTA” captures the total intra-regional 

trade bias or trade creation defined in a Johnson (1962) sense.  The dummy “imRTA” 

captures the extra-regional import bias of intra-RTA trade  or the import trade 

diversion as a result of changes to the import structure of the RTA where a negative 

and significant coefficient indicates that member countries have switched to importing 

from members rather than non- members.  Finally, “exRTA” captures the 

extra-regional export bias of the RTA to the rest of the world or the export trade 

diversion where a negative and significant coefficient means that the RTA has 

resulted in a member country preferring to export to members rather than 

non- members.

20

 

 

In the first instance, as a method of  explaining the world’s bilateral trade patterns, we 

estimate a relatively simple gravity equation with a single intra-regional bias dummy 

                                                 

19

  We acknowledge  however, that in Viners original welfare context we cannot make 

unambiguous conclusions about the degrees of trade creation and trade diversion without 

knowing exact tariff structures and relative price changes (World Bank 1999).  Soloaga 

and Winters (2001) also include three dummy variables but differ in their interpretation of 

trade creation and trade diversion.      

20

 The term export trade diversion was first used by Endoh (1999) and differs from 

definitions of trade diversion given by Balassa (1967), Johnson (1962) and Viner (1950).  

Elbadawi (1997) and Endoh (1999) state that whether a RTA is trade creating or diverting 

depends on the sign of the RTA dummies and not their movements over time.  The size of 

the coefficient however, can be affected by the country sample size.  As a consequence, it 

is more appropriate to pay attention to changes in the coefficient through  the RTA 

formation period rather than the level itself. 

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for four PTA’s (ASEAN, APEC, NAFTA and the EU).

21

  Second, we investigate the 

degree of the trade creation and trade diversion as a result of AFTA by incorporating 

our two additional dummies,  imRTA and  exRTA.  The degree of trade creation and 

trade diversion for  each RTA is extracted from the movement of the coefficients on 

the three dummy variables.  Finally, we estimate equation (2) for the intra-ASEAN 

trade only to better understand the intra-regional trade flows for the same five yearly 

periods.