Applied Econometrics and International Development Vol. 14-2 (2014) A GRAVITY MODEL APPROACH TO ANALYZING THE PERFORMANCE OF CARICOM MEMBER STATES ALLEYNE, Antonio1 LORDE, Troy Abstract This study examines the trade flows in commodities for CARICOM countries through the utilization of the traditional gravity model for . Per capita GDP differential, trade to GDP and language all impact trade positively. On the other hand, geographical distance, exchange rate and unexpectedly, historical trade relationships have negative effects on trade. The results suggest that management of the exchange rate is critical and that CARICOM countries may be served better by trading with countries with higher living standards. Keywords: CARICOM, gravity model, bilateral trade, JEL classifications: F10, F14 and F15 ______

1. Introduction The introduction of the Caribbean Association (CARIFTA)2 in 1965 provided the initial catalyst for the enhancement of trade within the Caribbean region. Following the enactment of the Revised 1973 Treaty of Chaguaramas and the establishment of the Caribbean Community (CARICOM) special alliance of nations ( and Economy) in 2001,3 a primary objective became the strengthening of relationships to provide an impetus for greater economic integration and cooperation among members. At present, members continue efforts to enhance intra-regional trade while working to improve international trade to quicken the pace of development. Despite the aforementioned initiatives, evidence suggests that total trade in CARICOM has been quite restrained, despite open markets access amongst members (Ramjeet 2009). Results published by the Caribbean Trade and Investment Report (CTIR) in 2010, support the view that the existence of significant imbalances in the growth of trade is a direct result of the increase in imports from non-CARICOM sources out- pacing the rate of expansion of within CARICOM (CARICOM Secretariat 2010).

1 Antonio Alleyne ([email protected] / [email protected]) Research and Planning Unit, Ministry of Finance and Economic Affairs 3rd Floor East, Warrens Office Complex, Warrens, St. Michael, Barbados. Troy Lorde, Department of Economics, The University of the West Indies, Cave Hill Campus, Barbados

2 CARIFTA was comprised of Antigua and Barbuda, Barbados, Guyana, and Trinidad and Tobago. 3 The grouping comprises Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname and Trinidad and Tobago. Applied Econometrics and International Development Vol. 14-2 (2014) As a consequence of special trading arrangements with Europe, CARICOM countries enjoyed the benefits—in terms of real income growth, employment and foreign exchange earnings—derived from agriculture (mainly sugar, bananas and other primary crops) and merchandise trade with extra-regional markets. However, this type of asymmetric trading later became incompatible with the World Trade Organisation’s (WTO) fundamental rule; that is, a must open up “largely all trade” between two partners. Comprehensive, symmetric and WTO compliant frameworks for bilateral trade between CARIFORUM4 countries and Europe—Economic Partnership Agreements (EPA)—were thus signed in Barbados in 2008. Elimination of preferential trading agreements suggested that the region would have to make greater choices among alternative paths. According to Lorde, Alleyne and Francis (2010), the EPA will bring with it significant challenges for the region. Notwithstanding the challenges, the substantial change in the economic environment can present opportunities for economic restructuring, development and institutional framework enhancements for all member countries (Lorde, Alleyne and Francis 2010, Rahman 2004). The -led growth hypothesis suggests that the expansion of aggregate exports have a favourable impact on economic growth (Balaguer and Cantavella-Jorda 2004). Feder (1983) argues that the assignment of productive resources to external demand- oriented sectors is a very important factor in eliminating allocated inefficiencies and increasing output levels. Moreover, the efficiency that can be found in external demand-oriented sectors is often prompted by the need to attain increased competitiveness in international markets. Therefore, with the new dispensation of more reciprocal trade, the focus of trading in primary products has been called into question, when seeking the best avenue for sustained economic growth and development. Considering that over the review period of this study, a significant portion of commodity trade (particularly imports) takes place with the developed world (Table 2), the impact of trade liberalization on Caribbean regional development is unclear. Regional signs point to a need for increased expansion in international markets, as intra-regional trade appears to show marginal promise for growth. It is thus important for CARICOM members to identify the countries, or regions, where the greatest potential for revenue gains exists. Hence the primary objective of this paper is to empirically examine the critical factors explaining trade flows in CARICOM. The paper is organized as follows. The next section provides a review of trade within CARICOM. Section three presents a review of the relevant literature on trade flow determinations. Section four introduces the empirical model, econometric methods and data used in the analysis. The results and analysis are presented next. The final section provides some concluding remarks.

2. CARICOM trade Several years after the 2008 global financial crisis, most CARICOM economies, particularly those heavily dependent on tourist travel from Europe and the USA, remain suppressed as a result of the prolonged financial turmoil in Europe and the

4 CARIFORUM is a grouping of CARICOM countries, excluding Haiti, and including the Dominican Republic. 146 Alleyne,A., Lorde,T. A Gravity Model Approach and Trade Performance of CARICOM States slowed economic recovery of other developed markets. However, high trade prices have resulted in increased growth in the commodity-based economies within the region, such as Guyana, Haiti and Suriname. Despite relative proximity to large consumer markets, CARICOM countries continue to be confronted with significant challenges. Small size, high transportation and production costs act to impede their competitiveness. The EPA, though, provides a window of opportunity regarding new prospects for technical cooperation and trade development. At the same time it opens the door for several new and existing market niches to be exploited. Notwithstanding, the global trading environment continues to be confronted by what has been branded as the worst recession since the 1930s. This has led to fewer opportunities for financing (trade or otherwise) in the region, compounded by the fact that the Caribbean credit market remains underdeveloped (Caribbean Centre for Money and Finance 2010). CARICOM economies remain below pre-recession levels of economic growth, recording either very low or negative growth rates, leading to deterioration of trade growth. Over the period 2000-2011, most member states registered annual commodity trade performance above 50.0 per cent of GDP (see Table1). Despite a noticeably declining trend, the region’s average remained above the world average for the same period. Only the Bahamas, Haiti, Jamaica, and St. Lucia showed a generally improving performance.

Table 1 - Merchandise Trade (% of GDP) Country Name 2000 2005 2010 2011 Antigua and Barbuda 58.3 58.8 47.7 46.9 Bahamas, The 41.9 37.1 42.4 48.8 Barbados 55.8 65.4 48.6 61.6 Belize 89.2 71.8 71.8 83.3 Dominica 61.9 57.3 54.8 51.6 Grenada 54.8 50.8 43.5 45.5 Guyana 150.3 162.6 100.8 112.5 Haiti 36.9 46.3 56.1 50.0 Jamaica 51.4 56.6 48.8 57.1 St. Kitts and Nevis 55.0 45.6 47.6 42.1 St. Lucia 52.1 60.5 71.8 68.4 St. Vincent and the Grenadines 52.8 50.8 56.2 53.8 Suriname 103.7 114.1 78.4 96.3 Trinidad and Tobago 93.0 97.2 83.4 102.3 Caribbean Small States5 65.7 72.6 65.7 75.9 World 40.6 46.7 48.5 52.3 Source: , and World Bank GDP estimates 2013

5 Caribbean small states include Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. 147 Applied Econometrics and International Development Vol. 14-2 (2014)

Table 2 CARICOM Imports and Exports Total Intra-Regional CARICOM Trade (US$ Billion) 2000 2005 2010 2011 Imp Exp Trade Imp Exp Trade Imp Exp Trade Imp Exp Trade orts orts Bal. orts orts Bal. orts orts Bal. orts orts Bal. Antigua and 0.04 0.01 -0.03 0.09 0.03 -0.06 0.04 0.01 -0.03 0.04 0.01 -0.03 Barbuda Bahamas 0.01 0.00 -0.01 0.01 0.00 -0.01 0.07 0.01 -0.06 0.17 0.00 -0.16 Barbados 0.23 0.12 -0.11 0.41 0.14 -0.26 0.13 0.13 0.00 0.60 0.20 -0.40 Belize 0.01 0.01 -0.01 0.01 0.02 0.01 0.01 0.02 0.00 0.02 0.03 0.01 Dominica 0.04 0.03 -0.01 0.05 0.02 -0.03 0.05 0.03 -0.03 n.a. n.a. n.a. Grenada 0.06 0.01 -0.05 0.09 0.01 -0.08 n.a. n.a. n.a. n.a. n.a. n.a. Guyana 0.10 0.08 -0.02 0.28 0.11 -0.17 0.47 0.12 -0.35 0.42 0.17 -0.26 Jamaica 0.40 0.05 -0.35 0.83 0.05 -0.78 0.83 0.07 -0.76 1.03 0.07 -0.96 Montserrat 0.00 0.00 0.00 0.01 0.00 -0.01 n.a. n.a. n.a. n.a. n.a. n.a. Saint Kitts and 0.04 0.00 -0.03 0.04 0.00 -0.04 0.03 0.01 -0.03 0.03 0.01 -0.02 Nevis Saint Lucia 0.08 0.01 -0.07 0.10 0.03 -0.07 n.a. n.a. n.a. n.a. n.a. n.a. Saint Vincent and 0.05 0.02 -0.03 0.07 0.02 -0.05 0.13 0.03 -0.10 0.15 0.03 -0.12 the Grenadines Suriname 0.11 0.01 -0.09 0.22 0.06 -0.16 0.36 0.30 -0.06 0.47 0.34 -0.13 Trinidad and 0.13 1.02 0.90 0.11 2.09 1.98 0.12 2.07 1.95 n.a. n.a. n.a. Tobago CARICOM 1.29 1.38 0.09 2.33 2.60 0.27 2.26 2.80 0.54 2.94 0.85 -2.08 Total CARICOM Trade (US$ Billion) 2000 2005 2010 2011 Imp Exp Trade Imp Exp Trade Imp Exp Trade Imp Exp Trade orts orts Bal. orts orts Bal. orts orts Bal. orts orts Bal. Antigua and 0.34 0.02 -0.32 0.53 0.12 -0.40 0.50 0.03 -0.47 0.47 0.03 -0.44 Barbuda Bahamas 2.00 0.55 -1.45 2.57 0.27 -2.30 2.86 0.62 -2.24 3.41 0.73 -2.68 Barbados 1.16 0.27 -0.88 1.67 0.36 -1.31 1.20 0.31 -0.88 1.78 0.51 -1.27 Belize 0.45 0.20 -0.25 0.44 0.21 -0.23 0.70 0.28 -0.42 0.84 0.40 -0.44 Dominica 0.15 0.05 -0.09 0.17 0.04 -0.12 0.22 0.03 -0.19 1.68 0.00 -1.68 Grenada 0.24 0.08 -0.16 0.33 0.03 -0.31 n.a. n.a. n.a. 6.44 0.00 -6.44 Guyana 0.57 0.38 -0.19 0.78 0.46 -0.32 1.45 0.56 -0.90 0.03 0.73 0.70 Jamaica 3.19 1.31 -1.88 4.88 1.51 -3.37 5.23 1.32 -3.91 0.25 1.60 1.36 Montserrat 0.02 0.00 -0.02 0.03 0.00 -0.03 0.00 0.00 0.00 0.38 0.00 -0.38 Saint Kitts and 0.20 0.03 -0.16 0.21 0.03 -0.18 0.27 0.03 -0.24 1.64 0.04 -1.59 Nevis Saint Lucia 0.36 0.04 -0.31 0.49 0.06 -0.42 n.a. n.a. n.a. n.a. n.a. n.a. Saint Vincent and 0.16 0.05 -0.11 0.24 0.04 -0.20 0.38 0.04 -0.34 0.00 0.04 0.04 the Grenadines Suriname 0.53 0.51 -0.02 1.05 1.00 -0.05 1.40 2.03 0.63 0.00 2.47 2.47 Trinidad and 3.31 4.27 0.97 5.69 9.61 3.92 6.48 10.9 4.50 n.a. n.a. n.a. Tobago 8 CARICOM 12.6 7.78 -4.88 19.0 13.7 -5.32 20.6 16.2 -4.45 16.9 6.55 -10.37 6 7 5 9 4 1

Over the review period, intra-CARICOM imports increased from US$1.3 billion in 2000 to an estimated US$2.9 billion in 2011, growth of 127.4 per cent. A significant portion of the increase was the result of growth in Jamaica’s growing regional import bill (moving from US$0.4 billion to US$1.0 billion). CARICOM’s intra-regional exports also expanded from US$1.4 billion in 2000 to US$2.8 billion in 2010, growth of 102.2 per cent. Notably, prior to 2011 Trinidad and Tobago maintained a regional market share above 70.0 per cent. Total CARICOM imports (from all trading partners)

148 Alleyne,A., Lorde,T. A Gravity Model Approach and Trade Performance of CARICOM States increased over the period moving from US$12.7 billion in 2000 to US$20.9 billion in 2010, then slipped to US$16.9 billion in 2011. With reference to the demands for the region’s products, total exports to all destinations expanded from US$7.8 billion in 2000 to US$16.2 billion in 2010. The visible trade deficit recorded in 2010 was in excess of US$10.0 billion (see Table 2).

3. Review of the Literature

The impact of international trade and its implications for the development of a country are among the oldest topics studied by economists. However, international trade remains a field of economic specialization that seems peculiarly prone to the disease of formalism (Blaug 1992). Adam Smith, a pioneer in the field, first explained the potential gains of unrestricted free trade—the theory of absolute advantage (Smith 1776). In a debate against restrictions on imports, Smith made clear his position, stipulating that a country’s trading activities (both imports and exports) would be determined by the market mechanism, not government policy. According to Krueger (1980, 289), “…markets would function well and provide growth if only policy makers would abstain from unproductive intervention.”

As time passed, a plethora of studies pointed to a number of factors that significantly impact the flow of international trade. The , based on Newton’s law of gravitation —the attraction between two entities is proportional to the product of their masses and inversely related to the square of the distance apart (Dascal, Mattas, & Tzouvelekas, 2002; Batra, 2004; Rahman, 2009)— remains a widely used empirical approach to bilateral trade patterns between geographical entities (Batra 2004). Although the gravity model was initially recognised for its success in predicting trade flows between countries, it was regarded by some authors as lacking a strong theoretical foundation (Anderson and Van Wincoop 2003). It was the inaugural work of Anderson (1979) that was recognized for providing a theoretical foundation for the gravity model, and justified its usefulness in empirical testing of bilateral trade.6 Many authors have since tried to link the gravity equation to formal economic theory or discussed the implications of the gravity model in a neoclassical world (Ricchiuti 2004). Subsequent to the work of Anderson (1979), Bergstrand (1985, 1989) examined the theoretical determinants of bilateral trade in a series of papers in which gravity equations are associated with simple monopolistic competition models (Martínez- Zarzoso and Nowak-Lehmann 2003). Parallel to these studies, Helpman and Krugman (1985) and Helpman (1987) showed that the gravity model can be derived from both the traditional and new theories of international trade. Within this context, Eaton and

6 Helpman and Krugman (1985), Deardorff (1998) and Anderson & Van Wincoop (2003) also contributed to improvements of the gravity model. 149 Applied Econometrics and International Development Vol. 14-2 (2014) Kortum (1997) later derived the gravity model from a Ricardian framework, while Deardorff’s (1998) contribution came from a Hecksher-Olin perspective7 (Rahman 2003). Despite remaining critical of the gravity equation’s application,8 Deardorff proved that if trade is impeded and all goods are produced by individual countries, the Hecksher-Olin model will return the same bilateral trade pattern as the model with differentiated products. Deardorff also added that if there are transaction costs within trade between countries, the distance variable should be included in estimation of the gravity model. Likewise, Rahman (2003) stated that the distance between partners is an ultimate factor in determining the volume of trade between them. Studies based on the general equilibrium approach, (Tinbergen 1962, Pöyhönen 1963, Bergstrand 1985, 1989) conclude that incomes of trading partners and the distances between them are statistically significant and obtained the expected signs (Ohuledo and Macphee 1994, Karemera and Smith 1999). Despite general acceptance, the gravity model was challenged on its failure to accommodate empirical evidence of comparative advantage (Ciuriak and Kinjo 2006). According to Ciuriak and Kinjo, this critique is particularly important as the gravity model is considered for policy applications such as identifying priority markets for trade promotion programs. Additionally, the potential for improved trade may be greater where complementary patterns of comparative advantage exist. In relatively recent research, Gu (2008) conducted a gravity analysis on commodity exports from China to 30 OECD countries for the period 1999 to 2005. The empirical results indicate that the traditional explanatory variables, GDP, GDP per capita and population have strong positive effects on China’s export trade, while distance and remoteness provided adverse impacts. These results demonstrate that trade cooperation applies significant positive effects on the country’s export trade. However, regional economic organisation and the exchange rate components were insignificant to China’s exports. Extensive studies were undertaken to analyse the determinants of bilateral trade between different countries (either based on an individual country or within regional/intra-regional trade bloc,) by employing the gravity model using a panel or time-series approach. For example, Coe and Hoffmaister (1998) estimate a gravity model to investigate the variation in bilateral trade between southern developing countries and northern industrial countries, in an effort to address the question of whether Africa’s bilateral trade with industrial countries is comparable to trade with other developing country regions. Results show significant evidence which support the view that restrictive trade policies have contributed to low levels of bilateral trade between African and industrial countries. The main findings of the study are that Africa’s trade is in fact unusual, but is explained by economic size, geographic

7 The proposition of Heckscher-Ohlin hypothesis (differences in factor endowments) is that a country has comparative advantage in the production of that commodity which uses more intensively the country's more abundant factor. 8 In his 1998 paper, Deardorff argues that an empirical model that can be derived from any of the conflicting theories is not the right tool for selection among them.

150 Alleyne,A., Lorde,T. A Gravity Model Approach and Trade Performance of CARICOM States distance, and population. However, after controlling for these various factors of bilateral trade, results suggest that Africa’s trade is not at all different. Subramanian and Tamirisa (2001) also explore Africa’s trade with other African countries as well with other developed and developing countries. Throughout the study, the authors separated the continent into two regions (Francophone and Anglophone). The authors posited that Africa, specifically Francophone Africa, is currently under-exploiting the trading opportunities available and has witnessed disintegration over time. Additionally, it was suggested that Anglophone Africa fails to keep pace with global integration. The authors however concluded that when Africa’s trade performance is measured relative to that of other developing countries, the disparity in performance is striking, because developing countries as a whole seem to have strengthened their links with the global economy over time. Rahman (2003) examines the factors of Bangladesh trade using the panel data approach with the generalised form of the gravity model. The author considers both economic and natural factors in determining the most appropriate form of the gravity model. The study spans data of 35 countries over 28 years (1972-1999). Results showed that Bangladesh trade is positively determined by the size of the economies and openness of the trading countries. Alternatively, transportation cost is found to be a significant but negative factor of influence to Bangladesh’s trade negatively. The author advocated that Bangladesh would improve its trade if the country more with its neighbours. The outcomes of the analysis form the basis in concluding that all trade barriers, between the countries involved, must be greatly liberalized in order to enhance Bangladesh’s trade. With reference to the Caribbean, particularly CARICOM, Egoume-Bossogo and Mendis (2002), using a log-linear form of the gravity model, attempted to explain the dynamics of trade among CARICOM countries with the rest of the world from 1980- 1999. Results indicate that through the process of integration, intra-CARICOM trade has increased. Simultaneously, trade with the rest of the world has been increasing, fuelled by trade liberalization measures. The authors further proposed the continuation of trade liberalization and a justification for increased regional integration, positing that the existence of the Eastern Caribbean (ECCU) has not constrained trade among the larger CARICOM. Results of this study reveal that WTO membership does not appear to affect the region’s trade positively. In 2006, Sandberg, Seale and Taylor used a gravity model approach to investigate the effects of regional integration, colonial legacies and linguistic ties on intra-CARICOM and international trade flows with selected countries, particularly North American, and European Union countries. According to the authors, results suggest that historical ties and regionalism have had considerable effects on CARICOM trade. However, the greater portion of this trade has occurred through significant unidirectional preferences and the elimination of such preferences could have significant implications for CARICOM exports (Sandberg, Seale and Taylor 2006). Evidenced by the pattern of CARICOM exports larger populations have a larger productive base with more opportunities for scale economies, and therefore a greater ability to export goods to the international market than the smaller countries; small island states face physical constraints that larger economies are immune to. Therefore a natural limit exists to the degree of self-sufficiency that can be achieved.

151 Applied Econometrics and International Development Vol. 14-2 (2014) 4. Data and methods

A panel data approach is used in to analyze trade flows in CARICOM. Consider the following general form of a panel data regression model: , = 1,…, N = 1,…, T (1) where represents the individual dimension and is the time dimension; and are vectors of exogenous variables, are vectors of constant parameter[ and the error term is assumed independently and identically distributed over i and t, with mean zero and variance . The error term is thus time-varying and represents the unobserved factors that change over time and affects the dependent variable. The choice of the appropriate estimation technique among the available spectrum is of prime importance (Carrere 2006). In the study done by Lewis-Bynoe and Webster (2000), the authors provide evidence which suggests that international trade for CARICOM countries cannot be considered as homogeneous. Under these circumstances, Slemrod and Shobe (1990) advocate that the application of either fixed effects model (FEM) or random effects model (REM) to panel data would be appropriate. The choice between the FEM and the REM was made by employing the Hausman (1978) test. The results of the Hausman reject the null hypothesis that there would be correlation between the bilateral specific effects and the explanatory variables; hence the FEM estimator is efficient. In his analysis Petersen (2009) noted that both FEM and REM models produce unbiased standard errors but only when the individual effect is permanent. This suggests that improvements to the efficiency of estimates can be made. Thus, the mode of estimation used in this study is a linear regression; Panel-Corrected Standard Errors (PCSEs) Many authors have hypothesized a gravity model for trade where the volume of trade between countries is a function of their incomes (GDPs), their populations, the distance between countries as an alternative to the cost of transportation, the rate of currency exchange which acts as a proxy for price and a set of conditional variables either facilitating or restricting trade between pairs of countries. As a result, the following variation of this study’s model equation has taken a slightly augmented form of the one tested by Rahman (2003), inclusive of the nominal exchange rate variable: lnTradetij = +  ln(GDPti*Gdptj) +  ln(GDPpcti*GDPpctj) +  ln(popti*poptj) +  lnDISTtij +  lnGDPpcDtij + 1 lnTRGti + 2 lnTRGtj + 1 lnLangtij + 2 RTAtij + tij (2) where: ln: denotes natural logs (x = : Total trade between partnering countries : GDP of country x : Per capita GDP of Country x : Trade to GDP ratio of country x : Population of country x

152 Alleyne,A., Lorde,T. A Gravity Model Approach and Trade Performance of CARICOM States

: Absolute difference between the per capita GDP of the partnering countries, introduced to identify a possible Linder effect9 : The Nominal Exchange Rate between respective countries : Distance between respective countries

Dummy (conditional) Variables Existence of a common official language between partnering countries : Both trading countries are existing members of the CARICOM grouping and thus benefit from the CSME regional trade agreements : Indicates the presence of an extensive trade relationships between a CARICOM member country and extra-regional trading partners (European counties, USA and Canada) : Unexplained disturbances : Time

International trade is calculated as the sum of exports and imports. Observations for exports and imports have been sourced from the United Nations Commodities Trade (UNCOMTRADE) online database at an aggregated level, using the Standard International Trade Classification (SITC) 3. The sample data covers the 13 CARICOM countries, coupled with 54 counter-part nations,10 which spans the top 10 trading partner of each CARICOM member state over the period of analysis (giving a potential total of 1300 observations).11 The United Nations National Accounts Main Aggregates Database was used to collect all other remaining variables utilized within this model’s regression analysis. GDP and GDP per capita12 are in constant 2005 US dollars. All currency variables are measured in US dollars. Population figures for all countries are considered in unit measurements. Data on the exchange rates are available in national currency per US dollar for all countries. These rates are converted into the country j’s currency in terms of country i’s currency. For the purpose of estimation, all data are logged.

9 According to Linder’s hypothesis, bilateral trade will be greater when the per capita GDPs of the trading countries are more similar. 10 These include: Anguilla, Belgium, Brazil, British Virgin Islands, Canada, China, Colombia, Congo, Costa Rica, Cuba, Denmark, Dominican Republic, Ecuador, El Salvador, Finland, France, Gabon, Germany, Guatemala, Honduras, India, Indonesia, Ireland, Italy, Japan, Republic of Korea, Mexico, Namibia, Netherlands, Netherlands Antilles, Nigeria, Norway, Panama, Portugal, Russian Federation, Spain ,Suriname, Sweden, Switzerland, Thailand, United Arab Emirates, United Kingdom of Great Britain and Northern Ireland, United States of America, Venezuela (Bolivarian Republic of) 11 Due to missing data for some of CARICOM member states, a number of observations had to be excluded. 12 According to Frankel and Wei (1993), per capita GDP is a useful indicator of the level of development and infrastructures that are essential to conduct trade between countries. 153 Applied Econometrics and International Development Vol. 14-2 (2014) Used as a proxy for transportation cost, distances in kilometres between partnering countries are taken from the online source, “Great Circle Distance Between Capital Cities”,13 which contains a database of 221 capital cities or 24310 unique two-way combinations. Additionally, as a measure integration into the world economy and an indication of the importance of international transactions relative to domestic transactions, the (average) trade to GDP ratio is calculated

The more open a country appears, the more it is expected to trade. However, it is noted that international trade is recognized as being more important to small countries, in term of physical space or population, surrounded by neighbouring countries with open trade regimes than the much larger, relatively self-sufficient countries, or geographically remote countries which are burdened by high transportation cost. As a result of the variable’s bias implications, the values used within this research are expressed as averages and caution is taken when concluding, particularly for policy purposes. Finally, the potential impact of the intra-CARICOM trade liberalization agreement is included, along with that of a historic tradition of trading relationships mentioned above. Impact (dummy) variables for liberalization of trade within CARICOM ( ), and a significant trading history ( ) were constructed. The model was further supplemented with a language dummy ( ) to capture the impact of differences in official languages on trade patterns.

5. Results and analysis Prior to estimating the specified model, the results of three different unit root tests (Breitung, IPS and Hadri tests) at level indicating that all variables are I(0), were presented in Table 3. It was concluded that all variables are non-stationary at level, implying that these variables share a common stochastic process. Results also indicate that the possibility of a long-run relationship through panel cointegration analysis, between variables should be investigated. From Table 4, the Kao Residual Cointegration test rejects the null hypothesis of no cointegration at 1 per cent and gives strong evidence that a long-run relationship exists between the variables. Table 5 presents the OLS estimates of the augmented gravity model. The results of all variables with the exception of three, GDP per capita, the population size, and the impact of being a signatory member of a regional trade agreement, were statistically significant at the 1 per cent level and had in most situations the expected sign, comparable to the findings of previous studies. According to the results, the model specified within this study fits the data with an acceptable level of accuracy, explaining 64.5 per cent of the variation in CARICOM bilateral trade. Income, distance, standard of living differentials, the exchange rate and the degree of openness variables are all found to be highly significant.

13 Source: http://www.chemical-ecology.net/java/capitals.htm (Last accessed: July 25, 2012) 154 Alleyne,A., Lorde,T. A Gravity Model Approach and Trade Performance of CARICOM States

Table 3: Panel Unit Root Tests – Breitung, IPS & Hadri Level 1st Difference Series Test Constant & Constant Constant Constant & Trend Trend Breitung 2.74521 2.65458*** LnTradeij IPS 0.76391 -0.22819 -5.72165*** -5.55368*** Hadri 12.4414 23.92640 7.39406 44.4036 Breitung 2.93271 -3.00E-12 lnTGRj IPS -2.30955** 0.41361 -14.35610*** -5.19144 Hadri 10.2638 25.61580 7.18651 44.7173 Breitung 2.14206 8.5754 lnTGRi IPS -3.57257*** -0.93267 -10.34660*** -0.15921 Hadri 9.13642 20.25060 2.83113 26.2161*** Breitung -2.15459 7.61647 lnPopij IPS 1.71007 -4.34345*** -22.99380*** -5.55965*** Hadri 9.22044 32.23910 7.26101 39.5275 Breitung 5.75044 (2) -9.31307*** lnGDPpcdij IPS -1.88365** 0.21490 -16.79770*** -5.41857*** Hadri 9.797 30.46270 8.41694 48.0947 Breitung 6.16893 (2) -10.774*** lnGDPpcij IPS 0.0798 0.66385 -21.41460*** -6.51546*** Hadri 11.754 24.85360 6.70454 36.0948 Breitung 5.63785 (2) -8.25666*** lnGDPij IPS -0.83583 -0.58518 -15.68480*** -3.98736*** Hadri 10.1137 29.56650 9.52454 54.9704 Breitung 2.10085 -2.6771*** lnERij IPS 2.03796 1.39572 -11.98550*** -5.94962*** Hadri 10.0403 34.60650 9.62693 44.8613 Breitung 0.54649 -7.24716*** LnDistij IPS -2.92241*** -0.48747 -17.56100*** -5.29478*** Hadri 6.95017 28.41650 5.72165 53.2301 Note: ***, ** and * denote significance levels of 1%, 5% and 10%, respectively. (2) indicates a 2nd difference of the variable

Table 4: Koa Cointegration Test t-Statistic p-value Coefficient Std. Error ADF -10.664 - - - RESID(-1) -25.878 0.000 -0.827 0.032

The product of incomes maintains a positive relationship with the flow of bilateral trade. This implies that rise in GDP in all sample countries including the CARICOM members is expected to boost CARICOM’s trade significantly; where a 1 per cent increase in the product of GDP leads to 0.35 per cent increase in trade for CARICOM. Implicitly, development of stabilization policies which contribute to an increase in economic growth for trading countries should be considered an important issue for policy makers in the CARICOM region. Despite the fact that the product of GDPs per capita is insignificant, per capita GDP differential between CARICOM member countries and the sample partners is significant and has a positive sign. The coefficient value of 0.09 implies that bilateral trade increases as the differences in factor endowment increases, but less than proportionately. The positive coefficient suggests that the Linder effect is dominated by the Hecksher-Olin effect from a CARICOM trade perspective. CARICOM may be served better by trading with countries that have higher standards of living.

155 Applied Econometrics and International Development Vol. 14-2 (2014)

Table 5: Regression Results (OLS Error Correction Model) LNTRADE Coefficient Std. Error LNGDP 0.350*** 0.051 LNDIST -0.628*** 0.023 LNPOP -0.005 0.050 LNGDPPC -0.024 0.052 LNGDPPCD 0.088*** 0.013 LNER -0.031*** 0.009

LNTGRi 1.097*** 0.066 LNTGRj 0.177*** 0.030 U(-1) -0.610*** 0.028 DUM_RTA 0.054 0.069 DUM_LANG 0.236*** 0.055 DUM_HT -0.306*** 0.052 Constant 0.0416 0.030 Number of Observations 985 R-squared 0.645 F-statistic 12.455 Prob(F-statistic) 0.000 Notes: ***, ** and * denote significance levels of 1%, 5% and 10%, respectively. Regression Method: Panel Corrected Standard Error (PCSE)

In the model, distance has the anticipated negative sign and registers a coefficient of less than 1; therefore the hypothesis that geographical distance is an impediment to trade cannot be rejected. The exchange rate has a negative impact on CARICOM’s bilateral trade. It is recommended that central banks within CARICOM should continue to efficiently manage the exchange rates movements in an effort to boost trade. Results show that, taken separately, a 1 per cent devaluation (increase in exchange rate) leads to a reduction of 0.03 per cent in bilateral trade with CARICOM countries. The variables representing openness to trade and ratio of total trade to GDP, of both country i and country j are significant and have the expected positive signs. This implies that CARICOM trade should grow as countries continue the process of full market liberalization. From the estimated results it is evident that greater openness leads to, other things being equal, an increase in CARICOM’s trade by an average of 1.1 per cent or 0.2 per cent, respectively. Unexpectedly, the variable ( ) which represents the impact of maintaining a historic trade link, is adversely relationship to trade (-0.306). This result may imply that the region cannot be assured of positive trade growth moving into the future and that the existing trade policy agreements between CARICOM member state extra- region partners should be revisited. Trade Agreements which once proved beneficial to the region may be no longer. Continuous relationship building (dynamic trade negotiations), with new and existing trade counterparts, may be a required solution. The common language ( ) variable is estimated with a positive coefficient

156 Alleyne,A., Lorde,T. A Gravity Model Approach and Trade Performance of CARICOM States of 0.236, and regarded as an influential factor to trade; an expected outcome when compared to the results of other studies on trade within the region. One particularly interesting result is seen in the variable which captures the impact of being an intra-CARICOM trade member ( ). Contrary to the findings of Egoume-Bossogo and Mendis (2002), it was found to be insignificant. These results suggest that the intra-CARICOM trade policy arrangements are not enhancing trade within the region. On the other hand, the results do support the reasoning that regional trading agreements are now overshadowed by the impacts of trade liberalization on a global scale. This suggests a need to revise current agreements, with a wider network focus before real trade benefits can be realized.

Implications and Policy Recommendations Taking into consideration the results found in this study, a number of factors affecting trade and the development of trade policy should weigh heavily within the decision- making process. The elimination of barriers to trade between CARICOM and its partners can prove advantageous. However, with increased global competition and a challenging probability for member states to reap net benefits, the removal of such barriers should be cautiously wagered against the need for a protected domestic market. Consideration should first be given to those trading markets, new or existing, which are closest in distance and not those necessarily where a long history has been established. Coupled with implementation measures to improve the modes of transportation efficiency, the region should realize increased gains from trade. Special attention should be placed on improving the development of the region as this study suggests that there may be a causal link between economic growth and trade performance. Growing economies facilitate a competitive environment which in turn improves the net benefits in international trade. Therefore any plans or policies related to trade must be linked to improved development.

6. Concluding remarks The objective of this paper was to identify the controlling factors of CARICOM trade with the rest of the world. The gravity model reveals that traditional variables played a significant role in the determination of total international trade for countries within the CARICOM region. A keen area of interest is the development policies for the region, as there may be a causal link between economic growth and the trade performance. The growth in GDPs of member states and their trading partners should result in improvements traded volumes. However, more significant gains may be derived if trading partners are not based only on previous historical ties. Note also that the Linder effect is dominated by the Hecksher-Olin effect and thus CARICOM countries may be served better by trading with countries that have higher standards of living. As expected, the sharing of a common language is favorable in the determination of trade, while geographical distance acts to impede trade. The exchange rate negatively influences CARICOM’s bilateral trade. Thus, the movement in the value of a currency requires effective management in an effort to improve total trade. Worthy of note, is

157 Applied Econometrics and International Development Vol. 14-2 (2014) that the policies used for intra-CARICOM may be considered ineffective and therefore increased consideration is required for extra-regional trade. It is apparent that the forming of the CARICOM union has brought with it significant gains via bilateral trade, but analysis indicates that the removal/reduction of trade barriers, particularly within the region, will not provide increase trade activity as the potential for increased trade may have reached its pinnacle. Worthy of further consideration is that net benefits may be determined by other factors to trade, for example, the level of competitiveness. It was pointed out, that in seeking ways to improve trade, the region should heavily consider the markets which are least remote and not those necessarily where a long historical ties exist. This is in addition to the need to improve transportation efficiency.

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