Tuesday 6 February 2018

Gravity eqation in internatioanl trade.


" Gravity Equation "  is a bit of economic jargon that I've only just come across. It's the name given to a finding by an economist called Thomas Chaney of the US National Bureau of Economic Research

Chaney's finding is that international trade between economies is directly proportional to the the size of the economies and inversely proportional to the distance between them.

I'll repeat that.

 International trade between economies is directly proportional to the the size of the economies and inversely proportional to the distance between them.

 In other words, if it really needs spelling out, economies trade most with their nearest and biggest neighbours. 

Just to prove I'm not kidding, here's the abstract of the findings.

 Thomas Chaney

NBER Working Paper No. 19285
Issued in August 2013
NBER Program(s):International Trade and Investment
The gravity equation in international trade is one of the most robust empirical finding in economics: bilateral trade between two countries is proportional to size, measured by GDP, and inversely proportional to the geographic distance between them. While the role of size is well understood, the role of distance remains a mystery. I propose the first explanation for the gravity equation in international trade, based on the emergence of a stable network of input-output linkages between firms. Over time, a firm acquires more suppliers and customers, which tend to be further away. I show that if, as observed empirically, (i) the distribution of firm sizes is well approximated by Zipf's law and (ii) larger firms export over longer distances on average, then aggregate trade is inversely proportional to distance. Data on firm level, sectoral, and aggregate trade support further predictions of the model


The implications for the claims of the Brexiteers are so obvious that they don't need spelling out, but just in case:

China is a big economy but a long way away from the UK:

So are the  US, India, Brazil and Argentina.

Korea is not quite so big but still a long way away.

There's a great big economy on our doorstep.  It's called the EU.

Chaney's finding could just be the reason why nearly half the UK's current international trade is with this same EU

Of course Chaney could be wrong, but as Oxford professor  Simon Wren Lewis points out:

 Gravity equations do not come from theory but from the data: countries are much more likely, even today, to trade with near neighbours than far away countries after allowing for other factors.

This finding makes a nonsense of the Brexiteers' claim that  the trade we currently have with our nearest neighbours in the EU, frictionless as it is popularly described, can be replaced, even increased, by amazing deals with far-away places once we are freed from the restrictions of the EU

It's also worth pointing out that  the alleged EU restrictions don't seem to have inhibited Germany, whose current trade with China is five times that of the UK.  It's also worth noting that Mrs Merkel has visited China nine times, compared with  Mrs May's two (though, of course, Mrs Merkel has been in the top job  longer - this blog tries to be fair.)

Mrs May's announcement yesterday that in no way will the UK remain a member of the EU customs union flies in the face of reality and makes a rod for our own back.

It is also incompatible with the aim of a "soft" border in Northern Ireland.

The call must be for our MPs, nearly all of whom understand the above and are as appalled as I am,  to find their  courage and put a stop to this nonsense.

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