Augmented Gravity Model: An Empirical Application to Mercosur-European Union Trade Flows

TLDR

The study applies a gravity trade model to evaluate Mercosur–EU trade flows and potential after recent trade agreements. The authors use a panel‑data gravity model with fixed effects across 20 countries (four Mercosur members, Chile, and fifteen EU members) to control for country‑specific factors and temporal dynamics. Results show that a fixed‑effects gravity model outperforms a random‑effects specification, and that infrastructure, income gaps, and exchange rates significantly influence bilateral trade.

Abstract

This paper applies the gravity trade model to assess Mercosur-European Union trade, and trade potential following the agreements reached recently between both trade blocs. The model is tested for a sample of 20 countries, the four formal members of Mercosur plus Chile and the fifteen members of the European Union. A panel data analysis is used to disentangle the time invariant country-specific effects and to capture the relationships between the relevant variables over time. We find that the fixed effect model is to be preferred to the random effects gravity model. Furthermore, a number of variables, namely, infrastructure, income differences and exchange rates added to the standard gravity equation, are found to be important determinants of bilateral trade flows.