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Institute for International Integration Studies IIIS Discussion Paper - page 11 / 41





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In an extension of this approach, Park (2002) also uses services data from GTAP to calculate tariff equivalents for a larger selection of countries and sectors. The gravity model is modified to include price indices to capture differences in prices between countries. This approach combines the price-based and quantity based methods of tariff equivalent estimation discussed in section 2.2. The inclusion of price indices in the gravity equation is first suggested in Bergstrand (1985, 1989). However, Feenstra (2004) argues that an aggregate domestic price index does not accurately capture the cost of importing a service into a country and that a comparison of differences between c.i.f. and f.o.b. prices would be more useful. The approach of Anderson and van Wincoop (2003) is based on such an approach, in that it implicitly solves for differences in prices to measure border effects.

Grunfeld and Moxnes (2003) apply a gravity model to the bilateral export of services and FDI flows using data from the OECD. Their regressors include the level of GDP and GDP per capita in the importing and exporting countries, the distance between them, a dummy variable if they are both members of a free trade area (FTA), a measure of corruption in the importing country and a trade restrictiveness index (TRI) to measure the barriers to services trade in the importing country. The TRI is the augmented frequency index based on research by the Australian Productivity Commission.

Their results suggest that the standard gravity model effects found in studies on trade in goods apply to services too. Trade between two countries is positively related to their size and negatively related to the distance between them and barriers to services in place in the importing country (measured by the TRI). They find that the presence of a FTA is not significant in the case of services. This result might be expected as many FTAs do not cover trade in services.

Grunfeld and Moxnes then proceed to model the impact of trade liberalisation on the flows of services using the estimated coefficients of the TRI variable. To model full liberalisation, they calculate the percentage change in services trade from reducing the TRI to equal that of the lowest country in the sample (arguing that simulating the effect of reducing the TRI to zero is unrealistic as it is unlikely that all barriers to trade would be removed entirely).

Kimura and Lee (2004) apply the standard gravity framework to services trade with the aim of comparing the results to the estimates for trade in goods. As with Grunfeld and Moxnes (2003), they use the OECD statistics on trade in services. They include the standard gravity model variables including adjacency and language dummies and in addition they include a measure of remoteness as a regressor (a trade weighted measure of the distance between the two countries). 13

Kimura and Lee estimate their gravity equation using a mixture of OLS and time-fixed effects. The major difference they report is that distance between countries is more important in services trade than goods trade. They suggest this implies there are higher transport costs for services but fail to provide any reason why this may be the case. Unlike Park (2002), who found language to positively influence trade in several service sectors, common language between the importer and the exporter is not found to be significant. FTAs are found to correlate positively with trade, which contradicts the finding of Grunfeld and Moxnes (2003) discussed above. The authors argue that whilst

13 As noted in the previous section, this type of measure of remoteness does not correspond to the underlying theory of the gravity model.


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