Potential Effect of Korea's FTA with its Trading Partners: Estimation by Augmented Gravity Models with Panel Data
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Abstract
This paper tries to analyze Korea's bilateral trade behavior with its major trading partners, using panel data of 39 countries during the past 21 years. First, a standard gravity model with conventional explanatory variables such as income and geographical distance is estimated. Second, this standard gravity model is augmented by adding new institutional and policy variables of APEC membership and trade liberalization index. Also, this augmented gravity model incorporates country- and time-specific random effects. With this augmented gravity model, many discrepancies between actual trade volume and trade volume estimated by standard gravity model are removed. Furthermore, using this augmented gravity model, the potential trade volume and trade balance after Korea's bilateral FTA are predicted. According to this prediction, Korea would substantially increase its trade volume with most of its existing trading partners. In particular, this increase would be noticeable in Asian countries such as India and Japan. Moreover, after FTA, Korea would improve its trade balance with most of its trading partners including Japan. Next, similar analysis is done with regard to Korea's intra-industry trade (IIT) by augmenting standard gravity model with structural variables. As a result of this analysis, it is predicted that Korea would increase its degree of IIT with most of developing countries. However, the prediction of potential increase of trade volume depends on the assumption that bilateral FTA would eventually bring about trade liberalization between two member countries.
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