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Greece's potential trade flows: a gravity model approach.

Article Excerpt
Abstract This paper attempts to access whether Greece's low openness is a reflection of its low trade integration primarily as a result of the country's relatively poor goods export performance. The analysis estimates potential trade flows for Greece through a gravity model using a panel of cross-country data, which cover bilateral trade flows concerning the EU member states. These flows are then derived by applying the estimated parameters to the Greek economy. The results show that actual Greek exports fall short of potential ones, while the opposite is true with respect to imports. This becomes more profound when the extent of intra-industry trade is included in the analysis. The findings for the Greek exports differ considerably from the corresponding ones for Portugal, a country with similar characteristics, manifesting the limited convergence of Greece's trade patterns towards the EU average as well as its unique geographical location relatively to the other EU countries.

Keywords Gravity model * Greek trade * Actual and potential trade patterns

JEL Classification F10 * F14 * F15

Introduction

The openness of the Greek economy remains relatively low, despite its participation in the European Union (EU) since 1981 (then European Community). (1) This is largely attributable to the relatively poor export of goods performance of the country. Table 1 reports the exports of goods expressed in millions of US dollars as well as in percentage terms of the corresponding import payments and GDP figures, and it refers to the period since the adoption of the Single Market in 1992. As shown, the poor goods export performance is easily ascertained as the receipts from exports of goods have been averaging about one third of the country's import payments, while they have been consistently below 10% of the country's GDP. The former ratio denotes the value of goods that the country is able to export for each dollar of imported goods and constitutes a measure of competitiveness in international commodity markets. Thus, the lower this index value, the less competitive the domestic production system, implying limited potential for offsetting the penetration of foreign goods into the Greek market.

The basic argument for participating in the EU and the move to the Single Market in 1992 has been the broadening of the free trade area and the creation of a large single market, where national production can get maximum advantage of economies of scale. This would reduce unit costs, enhancing productive efficiency while simultaneously offering a greater diversity of products and greater choice opportunities to EU consumers. Such an expansion would also lead to changes in the prevailing pattern of trade flows between member states, especially between the periphery economies, such as Greece and the more developed member states of the EU. Thus, for the former member state, this would imply changes in the trade patterns as their production structures adapt as a result of integration.

In this paper, we attempt to estimate the size of potential trade flows that correspond to Greece as a result of its participation in the EU and compare them with the actual ones. This will enable us to see whether the participation of Greece in the single market has led to convergence of its trading pattern towards that of the EU member states and give some possible explanations for the country's trade performance. In particular, we shall apply the methodology of a gravity model to estimate an export equation for the EU member states and their principal trading partners. By applying the estimated parameters to the Greek economy, the potential exports of Greece can be derived. In effect, and following this particular methodology, potential exports obtain when the country's trade patterns converge to the EU average. This will enable us to ascertain the export and import potential of the Greek economy and see how this compares to actual trade flows. Furthermore, the gravity model is used to provide a comparison with Portugal, a country with rather similar characteristics to those of Greece.

The analysis is presented in the remaining four sections. The first section presents a review of the theoretical foundations of the gravity model as well as the specifications to be used for the purpose of our analysis. The third section considers the methodology used in order to estimate the potential bilateral trade flows. The fourth section analyses the results concerning the projections of potential trade flows for Greece and how they compare to actual ones. Finally, the last section attempts to explain the results and state the conclusions of the analysis.

The Gravity Model

The gravity model represents a rather simple but robust approach to estimating bilateral trade flows on cross-section or panel data (Anderson and van Wincoop 2003). (2) The model introduces three broad determinants that explain the size of a bilateral trade flow: the importer's demand, the exporter's supply, and the cost of international trade, either with respect to transport or information. That is, the model attempts to explain the "natural" pattern of bilateral trade flows holding the economic factors constant. Bergstrand (1985) writes the model as:

[X.sub.ij] = [A.sub.0]([Y.sub.i])[.sup.[[alpha].sub.1]] ([Y.sub.j])[.sup.[[alpha].sub.2]] ([N.sub.i])[.sup.[[alpha].sub.3]] ([N.sub.j])[.sup.[[alpha].sub.4]] ([D.sub.ij])[.sup.[[alpha].sub.5]] ([R.sub.ij])[.sup.[[alpha].sub.6]] [u.sub.ij] (1)

where [X.sub.ij] is the value of exports from country i...

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