Analysis Of United States’ Trade Success Using The Gravity Model
The gravity model which is often seen in foreign trade is typically used to estimate the impact of various economic policies on exports, in addition to using the impact of preferential trade agreements, currency unions, and the economic cartel’s that be exposed through economist. While focusing on the United States in this research paper, it is important to discuss how different trade agreements have played a factor in the United States success as a major world player. In a lot of studies that have applied the gravity model to its full extent, we see that the application of the gravity model on the United States and its top trading partners such as China, Canada, Mexico, Japan, and many others plays pivotal roles on economic performance.
As the world’s largest market, the United States has been seen as the primary export target of many countries. As a primary export target, the trade pattern of the United States has radically changed with globalization. United States imports are not only controlled by the cost of goods, but rather by culture, distance, and social network between vast top trading countries. Outlining key determinants of the United States imports by using the gravity model will prove plausible determinants for the United States success. While choosing the United States to discuss, it is important to discover the overall top 10 trading partners that the United States has deemed necessary to trade with. For the United States, the top 10 trading partners are as follows:
- China ($636 billion)
- Canada (582.4 billion)
- Mexico ($557 billion)
- Japan ($204.2 billion)
- Germany ($171.2 billion)
- South Korea ($119.4 billion)
- United Kingdom ($109.4 billion)
- France ($82.5 billion)
- India ($74.3 billion)
- Italy ($68.3 billion).
When it comes to these figures, we look at goods that are traded, such as useable products whether they be raw materials or consumables. They do not include the exchange of services such as tourism or financial services. What can be largely discussed are the United States neighboring trading partners and how they have played a role in the United States success within itself and other trading partners through Trade Agreements. What can be seen through the United States history is the considerable growth in goods imported after the initiation of the North American Free Trade Agreement (NAFTA). Over this period, the average annual rate of growth of the United States dollar has increased by 10.8% which is rather large compared to the annual rate of growth of the United States GDP of 3.4%.
With the NAFTA and these results, it just shows that when it comes to location, there is a relationship between location and the gravity model. However, over this time, a lot of history has happened which has controlled the imports into the United States to slow down, largely in result to enhanced security measures at the United States board as a result of recent terrorist attacks across the globe as well as the financial crisis. These events have shown that the gravity model stays intact regarding trading partners although there are events that may shake overall analysis. When it comes to Canada, it can be easily seen through economic disposition and trade volume, that they are one of the United States largest trading partners. The volume of trade between them is seen as the greatest of any two countries in the world.
Going back to the early 2000s, we can see that Canada’s imports of $215 billion resulted from the United States, which accounted for over two-thirds of total Canadian imports, and 23% of United States exports. In the same year, Canada exported $286 billion of trade to the United States, which accounted for 87% of total Canadian exports, and 19% of total United States imports. With these large figures, it is no question that the United States tends to trade with Canada as it does with all other 9 countries listed of the European Union combined – which is rather shocking. However, the volume of trade between the United States and Canada is not surprising when you analyze the many economic and cultural similarities between the two countries. Nearly 90% of the Canadian population lives within 100 miles of the United States border, and that the border between Canada and the 48 contiguous states stretches for almost 4000 miles, making trade rather seamless. This relationship all started with the 1965 Auto Pact, where there has been an almost uninterrupted trend towards bilateral trade, leading up to the well-known North American Free Trade Agreement (NAFTA).
The North American Free Trade Agreement shows that if two countries were truly integrated, and the international border between them did not matter, the United States and other large countries such as China would be roughly the same in terms of volume of trade. This introduces the idea of the gravity model and namely discusses the importance of province and provides a real-world estimate of the factor behind “home bias” as a measure of the degree to which markets are segmented by international borders. From this point, we can directly see how the gravity model contributes to the overall trade between the two countries. Gravity models were first proposed stating that volume of trade could be estimated as an increasing function of the national incomes of the trading partners of the trading partners, and a decreasing function of the distance between them. While this function is namely proper, it became popular due to its perceived empirical success, however, tended to lack theoretical foundations to back its claims. The model has been seen in use by a series of economists to analyze the determinants of bilateral trade flows such as common borders, common languages, common legal systems, common currencies, common colonial legacies, and it has been used to test the effectiveness of trade agreements and organizations, such as North American Free Trade Agreement (NAFTA) and the World Trade Organization (WTO). It has also been seen in understanding international relations in a result of treaties and alliances on trade. When it comes to the United States, we can see how the gravity model has been able to provide several variables to find determinants for United States imports.
Reviewing the United States trade history, we can directly see how economic size of trading partners, geographical distance and trade openness of exporting countries has had a significant impact on United States imports. The gravity model has been able to describe and predict international trade flows between the United States trade partners. In the result of the gravity model, we can see that the United States is more likely to trade with countries that have a higher degree of trade openness. This result comes from empirical finding that states that countries which are the main bases of international direct investment and international manufacturing capacity, usually prefer more open trading arrangements. With open trade arrangements, comes trade agreements such as NAFTA and WTO. These organizations have a strong understanding of having trade partners and have a way of combating the gravity model.
The gravity model can be broken down into an equation which shows and captures the factors explaining trade flows between origin country, i, and its destination, j. The fundamental theory is an analogy to Newton’s gravity law where geographical distance would harm trade flows between countries, while economic size would have a positive effect on trade flow. The gravity model was first exploited between two countries as a proxy of transaction cost and using a countries market size for measuring potential demand and supply of trading countries. The basic theoretical model for trade between countries is shown by Fij =G´YiYj (1) Dij, where F denotes trade volume between countries i and j. Import, export and total trade are the most common dependent variables used in the gravity model. G is a constant term. Yi and Yj are the economic sizes of country i and j, and Dij is the geographical distance between the two countries. The trade gravity model shows that the trade flows between two countries are proportional to the product of each country’s economic mass, generally measured by GDP, divided by the distance between the country’s respective economic centers of gravity, generally their capitals.
Having an equation in the form allows us to better analyze how trade exists and why. With the United States, we can see that by the economic mass, measured by GDP, and close distance with neighboring countries has allowed for the United States to grow at a rapid rate and be a place for bilateral trade volume to be expressed. A takeaway from the equation and understanding the gravity model as a whole is shown by understanding that there is empirical evidence that the effect of distance on commodities trade is negative and significant at any level. Another understanding factor of the gravity model is that English as an official language in the export countries is a factor contributing positively to United States imports. The lack of a common language may inhibit communication while general misunderstanding impedes bilateral trade.
From these various factors, we can directly see that in different forms, the gravity model when displayed correctly, is an ultimate way to determine the import and exports between two countries and the results of each. Obviously, as mentioned in the text, there are tons of different inputs that make the gravity model challenging to understand and come up with a clear-cut answer for reasoning and justifying how well a country is performing and why trade exists between countries. From viewing a large world player such as the United States, we can directly correlate the gravity model and show that it has a stance in how trade happens and the results of the trade.
