Border effects

1. Border effects • Border Effects • Border Effects: the extent to which internal trade exceeds international trade after controlling for the economic determinants of commerce. • Internal trade measure: difference between domestic production and exports • Border effect as a measure of economic integration: perfect integration is defined as when the propensity for international trade is the same as that for international trade. • Literature: 1. evidence of their size (Country level analysis); (McCallum, 1995; Wei, 1996; Nitch, 2000; Head and Mayer, 2000) • 2.what are border effects? Are they really related to borders? Definition of the geographical entities separated by relevant borders COUNTRIES, REGIONS, PROVINCES • Intra-state trade (US: Wolf 1997, 2000; France: Head and Mayer, 2003) • - Country level factors (trade barriers, country regulations, legal frameworks) • - Other factors which operate at different level but are related to the economic geography (Spatial distribution of production/Social and business networks • ‘HOME BIAS’ in consumer or firm PREFERENCES)

2. Using gravity to test for border effects. • Home bias: preference towards home products; • Comparison between intranational trade and international trade; • The borderless world – “National borders have effectively disappeared” • Use gravity to test: • McCallum (1995) using data on trade flows between US and Canadian provinces (dummy=1 if in the same country)

3. Using gravity to test for border effects. • McCallum: Data referring to 1988 (before FTA Canada-USA was signed): Intra-national data flows only referred to Canada (exports from a province to other Canada provinces: DumCA=1); International: Exports from Canada provinces to USA states (DumCA=0) • Developments: addiction of data referring to 1993: intra-national data for both CA and USA. Another indicator=DumUSA=1 for trade between two USA states; • Dij is the distance between any two provinces or states; • Results

5. The importance of borders • 1988 or 1993: Coefficient on cross-provincial trade is quite high (3.09 to 2.75). Exp(3.09)=22; Exp(2.75)=15.7 • 1988: Canada-Canada province trade approx. 22 times Canada-US state trade; 1993: reduced to 15,7 • Border effects (all impediments to trade across borders) • Ontario’s shipments to British Columbia should be 0.6 times shipments to Washington (US) [Washington is richer] • BC receives 12.6 times more goods from Ontario than Washington • Border effect = 12.6/0.6 = 21 • Fallen to 12 since FTA implemented

6. The importance of borders • Anderson and Wincoop (2003): border effects have an asymmetric effect on countries of different size. More precisely have a larger effect on small economies. • Example: • US is 10 times bigger than Canada (economic size) • Without frictions to trade, Canada exports 90% of its GDP to US and sells 10% internally; US exports 10% of GDP • Suppose border effects reduce trade of a factor of ½ • => Canada exports 45% to US and sells internally 55% • Its internal trade has increased of a factor 5.5, cross-border has decreased by 0.5 => 5.5/0.5=11: internal trade has increased 11 times more than cross-border trade • =>US exports now 5% and sells internally 95%. Cross-state trade has increased only slightly more than 2 times cross-border trade

7. Alternative approach: taking into account of different (size) prices in different countries • Anderson and Wincoop (2003): • Imposes restrictions on the parameters of M; • Inverse indicator: DUMMY=1 for international (cross-border) trade 0 for internal trade; No distinction between Canadian or US cross-border trade (under a following assumption); • Introduces 2 new variables: price terms of the two countries (whose difference has a meaning). The two variables can be: • Constructed from Price Indexes data; • Estimated as a function of trade costs, where trade costs are a function of distance and other factors (intercept). (N.B. If trade costs are symmetric, then there cannot be a distinction between Canadian and US trade) => this methodology is quite complicated, because it involves the estimation of a recursive model of multiple equations.

8. Alternative approach: taking into account of different prices in different countries • Anderson and Wincoop (2003): 3.Introduce fixed-effects: two dummies one for the origin country and another one for the destination country: Di=1 if i is the exporter, 0 otherwise; Dj=1 if j is the importer, 0 otherwise; The two dummies are both equal to 1 only for cross-border trade observations. This implies: Di=(1-s)lnPi and Dj=(1-s)lnPj

9. Border effects in the enlarged EU area: evidence from importsto accession countries (Manchin and Pinna, AE, 2008) • is market fragmentation in the CEECs area more relevant than for EU countries? • border effects at the country level enlighting the role of barriers to trade • Why the CEECs? Barriers dismantled relatively recently • Address two points: • 1. the possibility of inflated border effects due to mismeasurement in distances (Head and Mayer, 2000). Information at the regional level both for CEECs and EU countries has been used in order to construct a weighted measure of distance both for between-countries and internal distances. Both arithmetic and harmonic means have been tested in order to check for differences in results when using a formula of aggregation more coherent with suggestions from previous gravity exercises. • 2. the need to isolate border effects from impediments to trade due to technical barriers. A comparison between internal and international movements of goods requires a proper control for protection measure which can still operate in a liberalised trade area. The issue is considered in the context of the impact of regulatory policies on international trade flows. We look at the extent of border effects for sectors grouped according to the approach adopted by the EU to remove technical barriers to intra-EU trade. The gravity model is applied to data that identifies separately sectors subject to the different approaches to the removal of technical barriers in the EU

10. (M-P, 2008) The issue of distance measurement • if internal distances are overestimated with respect to international distances border effects will be inflated, since the ‘true’ smaller distance would account for the ‘excess’ in within country exchanges. • Point to point measures have normally been used in the gravity literature for obtaining between-countries distances. With respect to internal distances several methods have been used, for example portions of the distance between a country and its neighbours, (Wei, 1996; Wolf, 1997, 2000) or distances between the two major cities of a country. • Defining i and j two states with respectively k and l districts, whose GDP is defined by the y variables, the formula that satisfies the definition of effective distance between countries i and j (dij) is: • MAIN ADVANTEGE: integrated methodology for calculating both international and intra-national distances. • q = 1 usual assumption in the literature (arithmetic average) • q = -1 results from gravity equations on the distance (harmonic average)

11. (M-P, 2008) Technical Barriers to Trade • Technical barriers to trade (TBTs) can arise when exporters have to comply with requirements for health, safety, environmental and consumer protection that differ from those in the domestic market. • EU approaches to harmonise national technical regulations and standards: • Old Approach: harmonisation of all product categories is achieved by very technical in-depth consultations, product-by-product, or component-by-component, harmonisation, resulting in long delays, applied to for example pharmaceuticals, foodstuffs and motor vehicles. • Mutual recognition: applied in cases where the harmonisation of regulations and standards is not considered essential from either a health/safety or an industrial point of view. Every country is obliged to accept into its territory products which are legally produced and marketed in another country. In other words, a producer or service provider who has fulfilled the requirements of his country of origin can sell his products or provide his services in the partner country. • New Approach: required when for similar products the different national regulations differ significantly and mutual recognition cannot be achieved. One of the key elements that allow harmonization under New Approach to be more effective than Old Approach is that the directives can be adopted by majority voting. Furthermore, only essential requirements are indicated for the producers or service providers thus giving greater flexibility.

12. (M-P, 2008) Econometric specification • o Controls for the heterogeneity in trade flows across countries and controls for business cycle effects Mátyás (1997, 1998a, 1998b). PANEL estimates: • FIXED Effects (dummies for both reporting and partner countries and periods) • Limits: time invariant factors (DISTANCE) are perfect correlates of fixed effects if country-pair effects • RANDOM Effects: Limits: 1. usual problem of independence between residuals and covariates; 2. specification has been proven to be inadequate whenever there is a specific interest in the openness of the economies under analysis (Mátyás, 1998b) • Our specification: LSDV ESTIMATOR with fixed effects for importer and exporter countries; • White Estimator VC matrix (robust standard errors) • o Censoring of the dependent variable across zero: • TOBIT specification: correction for the probability of having a zero value for the dep.var. Limits: inconsistent under NON NORMALITY and/or HETEROSCHEDASTICITY • CLAD estimator (Powell’s, 1984, 2001): minimization of absolute deviations from the median which, differently from the mean, is not affected by the censoring of the distr. of the dep.va • Tobit and CLAD estimator applied to a specification with country fixed effects

13. (M-P, 2008) Results