Analyzing The Determinants Of Pakistan’s Bilateral Trade Using The Gravity Model

Since the establishment of World Trade Organization(WTO) in 1995, the member countries are encouraged to adopt free trade policies. Economists believe that a country would prefer to trade with its neighboring countries to ensure cost efficiency, however, in reality this is not the case. Various studies have shown that the trade volume among countries within the same region is significantly low. It has been recognized that the bilateral trade patterns are well described empirically by the gravity equation, which relates trade between two countries positively to both of their incomes and negatively to the distance between them.This paper examines the determinants of bilateral trade between Pakistan and its major trading partners. Panel data for the time period 1999 to 2013 is analyzed for eight(08) countries, i.e. Pakistan, India, China, Brazil, Russia, South Africa, USA and Nigeria. An augmented gravity model is proposed and estimated employing three estimation techniques, i.e. Pooled-OLS, Fixed Effect and Random Effect models. After performing Hausman test, Random Effect model was found appropriate.Diplomatic relations and common border are introduced as dummy variables into the gravity equation. The results of this study show that diplomatic relations has proved to be a significant variable affecting Pakistan’s bilateral trade with the trading partners. Moreover, the overall R-square value of 0.804 depicts that the independent variables well explain the dependent variable, i.e. trade volume. The variables GDPexport and GDPimport have positive signs, while the negative sign of variable distance supports the general gravity equation. However, the insignificance of common border in this study reflects the trade preferences of Pakistan in current scenario, i.e. the trade volume between Pakistan and its neighboring countries including India and China is not up to the mark.I hope that this study will provide a different approach to the policy makers in analyzing trade potential of a country in general, as well as in enhancing Pakistan’s bilateral trade with its major trading partners in particular, thereby promoting regional integration.