ARE THERE SHORTFALLS in MENA TRADE? To What Extent Are They Due to the Rise in

EU Trade and Investment and Other Factors?

RANIA S. MINIESY

BRITISH UNIVERSITY IN EGYPT

JEFFREY B. NUGENT

UNIVERSITY OF SOUTHERN CALIFORNIAJune 8, 9, 2006

CNR – Institute of Studies on Mediterranean StudiesInternational Conference on “Bridging the Gap: The

Role of Trade and FDI in the Mediterranean”

INTRODUCTION Evidence: Although still controversial,

important evidence that trade growth is causal to income growth (Frankel & Romer 1999).

Growth has lagged in MENA at least until the exploding oil prices of the last two years.

Could slow trade growth contribute to this?

Why has MENA trade not been thoroughly investigated as a slow-growth determinant?

1) Other, possibly potentially more important, slow-growth determinants have been investigated.

Role of institutions (Elbadawi 2005 , Kuran 2004)

Human Capital Formation (UNDP 2003,2004, Pritchett, 1996)

High fertility rates and rapid population growth. (Williamson and Yousef 2002). Inflexible labor market institutions

(Pissarides and Vergazones-Varoudakis 2006, Campos, Hsiao and Nugent 2005).

Capital accumulation

Why has MENA trade not been thoroughly investigated as a slow-growth determinant?

2) The presence of numerous methodological difficulties that may have discouraged empirical investigations of both the determinants of trade and its effects on growth.

a. Problems of measurement of trade policy b. Traditional measurement OPENNESS is

an outcome variable (interdependence between trade and trade policy and economic growth. but c. Frankel & Romer 1999’s innovation.

Why has MENA trade not been thoroughly investigated as a slow-growth determinant?

3) Effects of trade on growth have sometimes been found to be considerably weaker for MENA countries than for other countries.(Makdisi, Fattah and Limam 2005)

4) The most common measure of openness (X+M)/GDP is often unusually large for MENA countries leading to conclusion that MENA countries do not trade too little

Purpose of this paper To use the gravity model to answer

a series of questions: 1) Do MENA countries trade more or less with themselves and with other countries than would be expected on the basis of gravity type explanations?MENA trades less than expected in both cases 2) What determines the extent of these trade shortfalls and the extent to which they might be reduced by the introduction of additional controls?

Purpose of this paper

3) Does EU-EE relationship compete with EU-MENA? EE has outperformed MENA in attracting FDI

IFDI Performance Indices: 1990-96 1997-2004MENA1.28 0.66EE 1.82 1.844) Can the shortfalls be reduced by introducing variables representing political shocks, (civil and international wars), trade policy considerations, and institutional considerations such as legal traditions and governance?

Organization of the paper Section 2: Gravity model and applications to the

MENA region.

Section 3: Identifies Data base used in this study, presents results with and without a dummy variable for MENA, and as additional explanatory variables are added.

Section 4: Compares results across different specifications and estimation procedures

Section 5: Compares MENA with East Asia and the MENA2 and MENA-World Trade Shortfalls across Specifications Summarizes and contains conclusions for policy and further research.

ALTERNATIVE MODELS FOR TRADE1. Trade equations involving relative prices and

other relative factors that reflect comparative advantage considerations.

2. CGE models.

3. Gravity models.

Advantages of Gravity Models Can be derived from underlying microeconomic

foundations (Bergstrand, 1985). Less subject to simultaneous and omitted variable

biases as compared to the other two models. Use much more reliable databases than CGE

models. Results shown to be quite robust to different

specifications, modeling assumptions and data sets and applicable to all kinds of countries and time periods (Leamer and Levinsohn, 1995)

Qualifications (Anderson and Van Wincoop) Can be Mitigated by Including Broad range of size and other controls and Fixed effects

Gravity Models and MENA Trade Applications to MENA region are relatively rare. Ekholm et al. (1996)

Low Potential for trade growth both within MENA and with EU. (May have discouraged further investigations in MENA).

Limitations of Study: Small sample of countries: 13 DCs and 11 LDCs for one year Small number of variables included Findings Counterintuitive and inconsistent with most other

studies. Hence, results could be misleading. Other Studies: Al-Atrash and Yousef (2000)

Miniesy, Nugent (2005), Miniesy, Nugent and Yousef (2004)

THE GRAVITY MODEL The standard gravity model estimated in the

literature and followed with certain modifications here is:Ln (Tijt) = β0 + β1 Ln Xijt + β2 Ln Yij + 1ij + 2t + uijt

Data: Virtually all countries in the world for 1970-2000 for data taken at three to five year intervals.

We focus on aggregate trade flows. The loglinear equation is limited to the variables

that are continuous. Many of the variables are either qualitative or dummy variables which are non-continuous.

Results: Basic Gravitygdp 1.021753

(0.02)***

gdppc_time -0.0363614(0.00)

***

LnGDPPCdiff -0.2578801(0.07)

***

gini_final -0.0122259(0.01)

**

gini_lngdp~f 0.0030216(0.00)

***

ll -0.2464937(0.05)

***

Results: More Basic Gravity

language 0.4676306(0.06)

*** cu 1.664587(0.18)

***

regional 0.6934212(0.18)

*** OneFTA -0.0057971(0.05)

colonizer 1.198327(0.17)

*** OneFTA90s

-0.051591(0.02)

***

colonial 1.057564(0.51)

** m2gdp 0.0000944(0.00)

***

Less Standard Gravity Variables

Common_L

-0.1068 (0.08)

war_intl -0.1479(0.22)

French_L -0.1030(0.06)

* war_intl_intensity

0.0791(0.12)

German_L

-1.668(0.47)

*** war_civil -0.0882(0.03)

**

Socialist_L

2.7892(0.30)

*** war_civil_intensity

-0.0731(0.04)

*

oil1npn -0.0045(0.00)

***

Impacts of MENA Interactions with Variables Named Below

Variable Basic Model gdppc distance areas border gov_ds

gdppc 0.32 0.35 0.32 0.32 0.32 0.34

distance -1.3 -1.31 -1.4 -1.3 -1.3 -1.31

areas -0.12 -0.12 -0.12 -0.14 -0.12 -0.12

border 0.63 0.39 0.64 0.62 0.7 0.68

gov_ds 0.09 0.09 0.09 0.09 0.09 0.09

MENA2 -2.38 2.32 -5.71 -3.68 -2.33 -2.21

MENA2_World -1.13 -0.46 -2.94 -2.25 -1.13 -1.15

MENA2_gdppc -0.3

MENA2_distance 0.44

MENA2_areas 0.1

MENA2_border -0.36

MENA2_gov_ds 0.18

MENA2_World_gdppc -0.04

MENA2_World_distance 0.21

MENA2_World_areas 0.08

MENA2_World_border 0.2

MENA2_World_gov_ds -0.03

Effects of Adding MENA2, MENA2_W and EU-EE Interactions with Year

Variable 1. Basic Model 2 MENA2 MENA 2-World

3. Col. 2+EU_EE

gdppc 0.32 0.3087 0.3085

distance -1.3 -1.4006 -1.4012

areas -0.12 -0.1480 -0.1483

border 0.63 0.6572 0.6568

gov_ds 0.09 0.1253 0.1253

MENA2 -2.38 -2.8553 -2.8578

MENA2_World -1.13 -1.1860 -1.1868

MENA2_1997 0.3974 0.3974

MENA2_2000 0.2231 0.2238

MENA2_W~1997 -0.2670 -0.2670

MENA2_W~2000 -0.3807 -0.3800

EU_EE -0.9443

EU_EE_only2000 0.2507

SUMMARY OF THE FINDINGS1) MENA countries trade less than their

Asian counterparts and than would be predicted on basis of gravity model

1) But less so for more distant countries2) Why?

Less trade-friendly policiesWeaker governance characteristicsCoincidence of EU-EE Trade expansion and

MENA decline but these do not affect the MENA trade shortfalls.

SUMMARY OF THE FINDINGS3) Having a common border has a less

positive impact on trade among MENA countries, suggesting that customs procedures, cooperation on procedures, infrastructure, at borders within MENA may be more detrimental to trade than elsewhere.

4) Generally speaking, controlling for non-observed omitted factors through fixed effects increases size of the estimated shortfalls. Hence studies without fixed effects may underestimate the shortfalls

TRADE POLICY RECOMMENDATIONS Eliminate existing restrictions on current

account transactions. Improve internal transport and

communications infrastructure Simplify and improve customs

procedures at the borders so that having common border with a trading partner would exert a stronger positive influence on trade of MENA than at present.

Reduce the likelihood and strength of civil and international conflicts that exert rather sizable negative influences on trade.

TRADE POLICY RECOMMENDATIONS Increase financial depth measured by M2/GDP. Promote greater and better implemented trade

pacts with both MENA and non-MENA countries

Improve compliance with agreements with penalties for non-compliance.

Improve governance in MENA countries and choose partners with better governance and at same levels of per capita income.

EU should impose stricter time limits on MENA for homogenizing policies and institutions.