The gravity model of trade has been the most commonly used analytical framework
in empirical studies of international trade flows. Tinbergen (1962) and Po¨yho¨nen (1963)
were the first to apply the “Newton’s Law of Gravitation” to international trade flows. In
its original form, the gravity equation explains bilateral trade flows by the economic size
of two countries and the distance between them. Since Anderson (1979) assigned the
gravity model with theoretical underpinnings for the first time, trade theorists have
found that the gravity model equation is consistent with theories of trade based upon
models of imperfect competition and with the Heckscher-Ohlin model (Helpman and
Krugman, 1985; Deardorff, 1998). Bergstrand (1989), extending the microeconomic
foundations for the gravity equation to incorporate factor-endowment variables in the
spirit of Heckscher-Ohlin model and taste variables in the spirit of Linder model[3],
developed the augmented version of the gravity model by including per capita income
levels for both exporters and importers as additional regressors[4]. The model has often
provided a useful tool to assess the trade-integration effects of regional cooperation such
as free trade agreements, economic partnership agreements and cross-boarder
infrastructure development. The intensity of non-standard trade relations is measured
by dummy variables for specific partners, which are added in the gravity equation.
Apositive and statistically significant coefficient for adummy variable shows that trade flows exceed the normal level, i.e. the level predicted by the countries economic sizes and
the distance between them. It implies that the economic cooperation in the region has a
preferential effect on the region’s trade flows.