Measuring Trade Creating Effects of RTAs: A Fixed Effect Estimation Approach

Abstract

This paper examines the relative magnitude of trade-creating and trade-diverting effects of some important RTAs using a panel dataset consisting of observations for every five years beginning in 1950 and ending in 1999, taken from Andrew Rose's gravity model (2004) database. The result of the Hausman test shows that the random effect estimators (RE) are inconsistent on account of the endogeneity bias. Therefore, fixed effect estimators (FE) are more suitable than random effect estimators. To avoid unobservable omitted variables, various estimation experiments were used from country-pair fixed effect, country-pair fixed effect combined with time dummy, and time-varying country dummies. Several features deserve attention. First, the trade-creating effects in five of the ten RTAs (EC, CACM, MERCOSUR, ASEAN, and SPARTECA) are rather striking. Second, it is interesting to see the trade-creating effects decreasing more in some RTAs (EC, CACM, MERCOSUR, ASEAN) if we use more rigorous experiments, that is, in terms of absorbing the effects of multilateral resistance. This could suggest that the trade-creating effects are over-estimated without controlling the country heterogeneity bias. Finally, the EU and NAFTA seem to be relatively less open trade blocs than are MERCOSUR and ASEAN.