Trade Potentials In Gravity Panel Data Models

In the last decade, a lot of effort has been produced in empirical international trade to explain bilateral volume of trade through the estimation of a gravity equation. A substantial share of this effort by scholars and Institutions regarded the estimate of trade potentials and the inference of trade effects of economic integration. In this paper we show - for the former euro-zone countries trade flows - how the result of a gravity model in terms of potential trade changes introducing time invariant country-specific effects and dynamics. In that case, our estimates give a more accurate account of the spread between actual and potential trade. Moreover, confronting the in-sample trade potential index derived from different estimators we give evidence of the convergence of the index towards the demarcation value corresponding to the equality between observed and predicted trade flows. Finally, we show how the sign of the index is not robust to a change of estimator, casting doubts on the soundness of strong policy implications based on the (in)existence of unrealized trade potentials.