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It Is Much Bigger Than What We Thought: New Estimate of Trade Diversion

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  • Juyoung Cheong
  • Do Won Kwak
  • Kam Ki Tang

Abstract

Conventional estimate of the trade diversion (TD) effect of preferential trade agreements (PTAs) tends to be much smaller than that of the trade creation (TC) effect. This paper ex- amines two sources of estimation bias of the TD effect. The first bias of TD arises from the difficulty in controlling for multilateral resistance and other unobserved time-varying country heterogeneity when estimating both TC and TD effects simultaneously due to perfect mul- ticollinearity. The second one is the underestimation of TD and arises from the failure to recognize that the concept of TD is inapplicable for a substantial proportion of PTAs and, thus, that the conventional method wrongly counts cases where trade cannot be diverted as cases where trade is not diverted. This paper corrects these two biases by using fixed effects and introducing a new measure of TD which provides a better mapping between the theoretical concept and data characteristics. Removing the two sources of bias leads to a twelve-fold in- crease in the estimate of the TD effect. It is found that the total TD effect is comparable to the TC effect in dollar terms.
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  • Juyoung Cheong & Do Won Kwak & Kam Ki Tang, 2015. "It Is Much Bigger Than What We Thought: New Estimate of Trade Diversion," The World Economy, Wiley Blackwell, vol. 38(11), pages 1795-1808, November.
    • Handle: RePEc:bla:worlde:v:38:y:2015:i:11:p:1795-1808
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    2. Zongo, Amara, 2020. "The Impact of Restrictive Measures on Bilateral FDI in OECD Countries," MPRA Paper 101929, University Library of Munich, Germany.
    3. Karin Mayr-Dorn & Gaia Narciso & Duc Anh Dang & Hien Phan, 2023. "Trade diversion and labor market adjustment: Vietnam and the U.S.-China trade war," Trinity Economics Papers tep0923, Trinity College Dublin, Department of Economics.
    4. Korn, Tobias & Stemmler, Henry, 2022. "Your Pain, My Gain? On the Trade Relocation Effects from Civil Conflict," VfS Annual Conference 2022 (Basel): Big Data in Economics 264095, Verein für Socialpolitik / German Economic Association.
    5. Jönsson, Oskar Martin & Presberger, David & Pfister, Stephan & Bernauer, Thomas, 2023. "How to estimate whether preferential trade agreements contribute to international environmental impact shifting. A new methodology and empirical illustration for Switzerland," Ecological Economics, Elsevier, vol. 205(C).
    6. Ficarra, Giovanni Maria & Millemaci, Emanuele, 2024. "CETA, an ex post analysis," MPRA Paper 119696, University Library of Munich, Germany.
    7. Sangyup Choi & Davide Furceri & Chansik Yoon, 2021. "Policy uncertainty and foreign direct investment," Review of International Economics, Wiley Blackwell, vol. 29(2), pages 195-227, May.
    8. Kirill Muradov, 2021. "Towards input–output‐based measurements of trade creation and trade diversion," The World Economy, Wiley Blackwell, vol. 44(6), pages 1814-1841, June.
    9. Korn, Tobias & Stemmler, Henry, 2022. "Your Pain, My Gain? Estimating the Trade Relocation Effects from Civil Conflict," Hannover Economic Papers (HEP) dp-698, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.

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