RANIA S. MINIESY BRITISH UNIVERSITY IN EGYPT JEFFREY B. NUGENT UNIVERSITY OF SOUTHERN CALIFORNIA

1. 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 CALIFORNIA June 8, 9, 2006 CNR – Institute of Studies on Mediterranean Studies International Conference on “Bridging the Gap: The Role of Trade and FDI in the Mediterranean”

2. 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?

3. 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

4. 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.

5. 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

6. 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?

7. 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 1997-2004 MENA 1.28 0.66 EE 1.82 1.84 4) 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?

8. 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.

9. ALTERNATIVE MODELS FOR TRADE 1. Trade equations involving relative prices and other relative factors that reflect comparative advantage considerations. 2. CGE models. 3. Gravity models.

10. 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

11. 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)

12. 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.

13. Results: Basic Gravity

14. Results: More Basic Gravity

15. Less Standard Gravity Variables

16. Impacts of MENA Interactions with Variables Named Below

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

18. SUMMARY OF THE FINDINGS • MENA countries trade less than their Asian counterparts and than would be predicted on basis of gravity model • But less so for more distant countries 2) Why? Less trade-friendly policies Weaker governance characteristics Coincidence of EU-EE Trade expansion and MENA decline but these do not affect the MENA trade shortfalls.

19. SUMMARY OF THE FINDINGS 3) 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

20. 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.

21. 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.