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European Research Studies Journal Volume XXII, Issue 2, 2019 pp. 265-281 Estimating Gravity Model in the Czech Republic: Empirical Study of Impact of IFRS on Czech International Trade Submitted 25/01/19, 1st revision 03/02/19, 2nd revision 14/03/19 accepted 16/04/19 Erginbay Ugurlu1, Irena Jindřichovská2 Abstract: Purpose: In this paper, we test the influence on foreign trade and FDI by using the gravity model within the EU. The influence of IFRS is also tested, although we might expect that its influence will be smaller than that of other factors. Design/Methodology/Approach: According to the gravity model, countries are trading according to their proximity and also according to the size of their GDP. Negative influence is played by trade barriers and positive by common traditions and a common political background. Big countries trade a lot between each other, e.g., the USA and Canada on the same continent or the USA and Germany in different continents. Smaller countries, like the Czech Republic, do not have such an impact on the scale of world trade. The size of exports /imports is influenced by the fact of whether or not they are part of some trading bloc, e.g., the EU in Europe or NAFTA in America. Accounting rules, namely IFRS, are expected to be perceived as a positive influence on the world trade of a particular country and a country´s FDI (Foreign Direct Investment). Findings: Contrary to our expectations, we have found that the influence of IFRS is not insignificant and is more pronounced after the year 2010 which coincides with the change of local regulations. Practical Implications: The findings establish an interesting signal relating to perceiving the increasing quality of the Czech economic environment including accounting regulations. Originality/Value: Based on our methodology accounting rules, namely IFRS, are expected to be perceived as a positive influence on the world trade of a particular country and a country´s FDI (Foreign Direct Investment). Keywords: Gravity model, export, EU, international trade, IFRS. JEL Codes: M42, M48. Article type: Research article. Acknowledgments: This paper was prepared with the support of Metropolitan University Prague, Project No. 68-02. 1Istanbul Aydın University, Turkey, [email protected] 2Metropolitan University Prague, Czech Republic, [email protected] Estimating Gravity Model in the Czech Republic: Empirical Study of Impact of IFRS on Czech International Trade 266 1. Introduction and Motivation International trade is an essential factor for the economic development of countries. It also leads to better economic performance for economies, especially for emerging market economies. The Czech Republic is one of the emerging economies in Europe that its economy expanded by 4.3% in 2017 and this growth rate is the second-fastest rate in a decade of the country (EC, 2018). The main driver of this growth is export. Export and import which means international trade of the countries have been investigated and numbers of theories have been developed for these issues such as the comparative advantage theory, and the absolute cost theory. In the economics literature, the gravity model is used to investigate international trade between countries. We consider that international trade is affected by many reasons. Although there is no theory about the effect of the accounting of the firms on international trade, we claim that the accounting standards have a relationship between international trade. IFRS was introduced as a compulsory feature of accounting, in Europe, in 2005. The major purpose was to enable the use of information for financial markets and investors even though other positive aspects have been perceived by external and internal users of IFRS regulations. In 2010, there was an institutional change in Czech regulations as the Ministry of Finance allowed and encouraged the use of IFRS by Czech companies. IFRS could be used as a base for accounting purposes but, for tax purposes, the results still had to be accounted for according to Czech Accounting Standards (CAS) rules. In the Czech Republic, there is an obligation to prepare to account according to Czech standards for the purpose of calculating the tax base. But there was a change in regulations in 2010 when IFRS was allowed to be used within Czech companies that were part of bigger international groupings. These subsidiaries were allowed to use IFRS as the primary standards rules, but subsidiaries, which are part of international companies, can use IFRS as their primary accounting standards and translate the relevant parts to CAS for tax purposes (Jindrichovska and Kubickova, 2017; Andre, 2017). This instructional change was described in many academic works, e.g., Jindrichovska and Kubickova (2016) and (2017), Prochazka (2017), Denisova et al. (2017) and others. To investigate this relationship, we will use the gravity model. The gravity model in economics comes from Newton’s “Law of Universal Gravitation” which was proposed in 1687. It states that every two particles in the universe attract each other. The formulation of the law as follows for two objects i and j. (1) E. Ugurlu, I. Jindrichovska 267 where; is the attractive force, are the masses and is the distance between the two objects, G is a gravitational constant depending on the unit of measurement for mass and force. Although it is based on physics, it has long been one of the most successful empirical models in economics (Anderson, 1979; 2011). The Gravity equation to model the size of bilateral trade flows between any two countries was firstly presented, in 1962, by Jan Tinbergen (Muratoglu, Ugurlu and Muratoglu, 2017). The gravity model equation in economics is formalized as follows (Roy and Rayhan, 2012). (2) where is the value of the bilateral trade between country i and j, and are country i and j’s national incomes, respectively. is a measure of the bilateral distance between the two countries. After logarithms of the equation are taken, we have Equation 3 which is below: (3) According to some literature, the gravity model in economics was not very heavily used, and it was somewhat disconnected from to the family of economic theory. However, gravity has long been one of the most successful empirical models in economics (Anderson, 1979; 2011). Incorporating the theoretical foundations of gravity into recent practice has led to a richer and more accurate estimation and interpretation of the spatial relations of international trade described by gravity. Recent developments are reviewed here with suggestions for promising future research both at the macro level and on the level of individual industries. In this paper, we apply the gravity model to the special conditions of the Czech Republic – a small open economy that was transformed from a planned economy to a market system at the beginning of the 1990s. In particular, apart from relying only on data linked to international trade (bilateral imports and exports within the EU) we are also interested in the impact of a particular institutional feature – the introduction of IFRS into Czech accounting and we are searching to see whether we will find any evidence as to the importance of this variable. Here we are testing the gravity model and, on the top of that, we will add the IFRS indicator to see whether this institutional change had any importance for Czech imports and exports as expected in the accounting literature. We test the volume and structure of international trade prior to 2010 and after 2010. The structure of the paper is as follows: Section 1 provides an introduction and motivation, Section 2 characterizes previous literature on the gravity model, generally, and studies of the gravity model in the Czech Republic, in particular. It Estimating Gravity Model in the Czech Republic: Empirical Study of Impact of IFRS on Czech International Trade 268 also characterizes relevant IFRS studies in the Czech Republic. Section 3 concentrates on methodology and describes the model. Section 4 characterizes relevant data and provides descriptive statistics. Section 5 summarizes the results and suggests avenues for further research. 2. Literature Review 2.1 Studies on the Application of the Gravity Model Many scholars have investigated the issues of various features of international trade using the gravity model, in particular, in different economies within particular economic blocs. A study by Paas and Tafenau (2005) uses the gravity equation to determine whether it describes trade integration of the EU-25 countries and whether there is any difference for the Baltic Sea Region (BSR). The results suggest that the BSR represents an exception within the EU, as the new trade theories cannot be used to explain BSR trade to the same extent as for the whole EU. Comparative advantages are the main basis for intensive trade relations within the BSR. Sichei, Erero, and Gebreselasie (2008) employ an augmented gravity model to South Africa’s exports of motor vehicles, parts and accessories to 71 countries during 1994-2004. The paper aims to determine which countries South Africa has, and has not, reached with its export potential and to determine whether there are any barriers to exploiting the export markets. Some of the variables related to the trading partners that increase South Africa’s exports are GDP, government effectiveness, the English language, the use of left-hand drive vehicles, and EU, Africa, NAFTA, etc. membership. The results show that there are several countries where South Africa could export, but certain barriers exist, such as geographical distance, high import tariffs, and the lack of trade agreements. Ravishankarand and Stack (2013) employ a stochastic frontier specification of the gravity model to determine trade efficiency against the maximum potential level, using bilateral export data between 17 Western European countries and ten new member states during 1994 and 2007.

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