eThesis - School of Business electronic theses

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The target in this thesis is to study the influence of the regional trade agreements of the BIC-countries (Brazil, India and China) on trade flows by using a gravity model. In this thesis it is investigated how much BIC-countries’ regional trade agreements explain of the bilateral trade flows during the time period 2001-2008 and whether there is trade diversion. In addition, the characteristics of the countries influencing on trade creation and diversion are studied.

In the empirical part the gravity model is used. Normally, the gravity model is used to explain the variation in the country pairs’ trade flows and the influence of regional trade agreements on possible trade creation and diversion. The influence of regional trade agreements on trade is estimated by using the OLS and Instrumental Variable (IV) estimations. Four cultural variables were chosen to be instruments for a regional trade agreement variable.

The estimation results indicate that the bilateral trade flows in the BIC-countries increased 76 % during the time period 2001-2008. In addition to trade creation, a large trade diversion was found. The post-estimation tests revealed that the OLS-model gives more reliable results than IV-method when the language was included in cultural instruments. Opposite results were achieved when language was excluded from the instruments. From eight country characteristics that were studied distance, common border and common continent had a positive impact on the trade creation, but negative impact on trade diversion. The impacts of cultural variables on trade creation and diversion were mostly in line with the theory of natural trading partners.