Does Regionalism Promote Intra-Regional Trade? The Case of ECO

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Does regionalism promote intra-regional trade? The case of ECO
Article in İktisat İşletme ve Finans · October 2014

DOI: 10.3848/iif.2014.343.3935
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İktisat İşletme ve Finans 29 (343) 2014 : 45-70
www.iif.com.tr
doi: 10.3848/iif.2014.343.3935
Does regionalism promote intra-regional trade?

The case of ECO
Khadim Hussain (a) Jianhong Xue (b)
Received 11 September 2013; received in revised form 1 August 2014;

accepted 14 August 2014
Abstract.
We apply the gravity model to assess determinants of trade in the Economic Cooperation
Organization (ECO) region. A particular attention is paid to evaluate the impact of ECO
on regional trade. The model is estimated for a sample of 34 countries, the ten members
of ECO and 24 as their main trading partners for a period of 32 years. Our results
show that gravity model explains the trade flows well in the ECO region. We also find
contiguity, common language and common religion as determinants of trade in the region.
Importantly, the ECO dummy variable, which is the variable of our interest, is positive and
significant in all the four specifications used, implying that the ECO membership foster
trade in the region.
Keywords: Regionalism, Trade, ECO, Gravity Model, Panel Data.
JEL Classification: C23, F15.
Özet. Finans Krizi Sırasında Türk Endüstrilerinin Risk Durumları

Bu çalışmada, İMKB’de yer alan endüstri indekslerine dayanarak global finans
krizi öncesinde ve sonrasında Türkiye’de bulunan alt-sektörlerin risk durumları analiz
edilmiştir. İlk olarak 19 alt-sektöre ait tanımlayıcı istatistik değerleri sunulmuş, ardından
GARCH(1,1) kullanarak indekslerin zamanla değişen varyansları hesaplanmıştır.
Riske-Maruz-Değer (VaR) tahminlerinin başarısını değerlendirmek için Kupiec ve
Christoffersen Testleri kullanılmıştır. Daha detaylı bir analiz yapabilmek için inceleme
süresi iki alt-döneme bölünmüştür: 2004(Nisan)-2007(Temmuz) ve 2007(Ağustos)-
2013(Mart). Bulduğumuz sonuçlar, her ne kadar GARCH (1, 1) kullanan VaR modeli %99
güven seviyesi için güvenilir gözükse de, %95 ve %90 güven seviyelerinde aşırı kayıpların
adedini doğru tahmin etme açısından göreceli olarak daha az güvenilir olduğunu ortaya
koymaktadır. Dahası, bu çalışma global finans krizinin GARCH (1, 1) kullanan VaR
(a) Khadim Hussain is an Assistant Professor at Department of Economics, Mirpur Univer-

sity of Science and Technology (MUST), Bhimber Campus, Bhimber, AJK, Pakistan, and
a Post Doctorate Research Fellow at College of Economics and Management, Northwest
A&F University, 3 Taicheng Road, Yangling, Shaanxi 712100, P. R. China. Cell. Phone #
+923455564766, Email: economist1980@yahoo.com
(b) Jianhog Xue is a Professor of Economics at College of Economics and Management, North-
west A&F University, 3 Taicheng Road, Yangling, Shaanxi 712100, P. R. China, Telephone (of-
fice): +86-29-87081405, Cell. Phone # +8613186121128, Email: xuej@nwsuaf.edu.cn
Corresponding author
2014© Her hakkı saklıdır. All rights reserved.
İktisat İşletme ve Finans 29 (343) Ekim / October 2014
INTRODUCTION
Regional integration (regionalism) has been around for centuries.
Throughout modern history, nations have been protecting their trade interests
through regional agreements. Regionalism has accelerated after World War II
and become even more widespread in 1990s. Eventually, with the beginning
of new century, its pace has been increased drastically. Besides the pace, it
has changed its form as well considerably, during last 60 years. It has shifted
successfully from simple border measures i.e. tariff reductions “shallow
integration” to a complex paradigm of regional policies and institutional
integration “deep integration” (Lawrence, 1996). The new regionalism
consider the global issues such as institutional frame work, services, capital
flows, investment, product standards, intellectual property rights, regulatory
systems, labor and environment issues and so on, even issues like poverty
alleviation, rural development and tourism (Whalley, 2008) which were
considered out of its scope earlier.
According to WTO, 319 regional trade agreements (RTAs) are currently
in force and some 511 notifications of RTAs had been received by the GATT/
WTO. Regionalism had a slow pace from 1950 to 1990, the number of
RTAs increased to almost 70 in these 40 years. Subsequently, it accelerated
manifestly, with the number of RTAs more than doubling over the next five
years and more than quadrupling after 1995 to reach 319 to date. The average
number of RTA participants per WTO member has risen from an average
of about 2 RTA in 1990 to over 12 in 2011 (WTO, 2011). The rise in the
regionalism, and its acceleration from the early 1990s onwards, has been
extensively discussed (Anderson and Blackhurst, 1993; Bergstrand, Egger
and Larch, 2010; Chen and Joshi, 2010; Egger and Larch, 2008; Freund,
2000; Lester and Mercurio, 2009; Liu, 2010; Mansfield and Reinhardt, 2003).
Besides developed countries, developing countries also actively
participated in regionalism. After a success story of signing RTAs with
developed countries (North-South regionalism), developing countries are also
participating in RTAs with developing countries (South-South regionalism).
Hence, South-South regionalism represents now two-thirds of all RTAs in
force and North-South about one-quarter, this ratio was totally opposite in
late 1970s (WTO, 2011). The South-South regionalism has potential benefits
for developing countries (Birdsall and Lawrence, 1999; Mansfield and
Reinhardt, 2003). Asia, despite its increasing economic importance joined the
integration process lately, however, become more active in signing the RTAs
recently. Over the last ten years, Asian countries have signed almost half the
RTAs concluded over that period, their participation were only 5 per cent in
the1990s (WTO, 2011).
46
The Economic Cooperation Organization (ECO) is an inter-governmental

regional organization. It was originally established as Regional Cooperation for
Development (RCD) in 1964 by Iran, Pakistan and Turkey. It was renamed as
ECO in 1985. In 1992 the organization was expanded to include Afghanistan,
Azerbaijan, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan and
Uzbekistan. Having common boundaries with European Union, Russia,
China, India, Middle East and Africa, it links up vast regions in closer trade
and economic relations. The geographical importance of the region has been
playing the role of a bridge between East and West from ancient times. The
main objective of the organization is sustainable economic development of
the region, which has to be achieved through the progressive removal of trade
barriers and the promotion of intraregional trade. The Organization also aspires
to create a greater role of the region in the growth of world trade and gradual
integration of the Member States’ economies with the global economy. Over
the past 20 years, the member states have been collaborating in priority areas
such as trade, transportation, energy, agriculture and so on, to accelerate the
pace of regional development. ECO Trade Agreement (ECOTA) was signed
by member states in July 2003 in Islamabad. It is now in the implementation
phase would help liberalize and open up regional trade. The member states
are negotiating now to establish a Free Trade Area in the region by the year
2015 as envisaged by ECO Vision 2015.
The customs unions theory (Kemp and Wan, 1976; Lipsey, 1957; Meade,
1955; Viner, 1950) provides the formal analysis of regionalism. In this
framework, the economic impact of regionalism is determined by two effects:
trade creation effect and trade diversion effect. The applied literature on the
estimated welfare impacts of regionalism is large and growing. Several studies
test the traditional theories on the net welfare effects of RTAs, and reach mixed
conclusions (Acharya, Crawford, Maliszewska and Renard, 2011; Anderson
and Blackhurst, 1993; Baier and Bergstrand, 2007; Carrere, 2006; Chang and
Winters, 2002; Clausing, 2001; Egger, 2004; Frankel, Stein and Wei, 1995;
Freund and Ornelas, 2010; Krishna, 2003; Magee, 2008). However, the most
part of the literature supports a consensus view that RTAs have been net
trade creating and hence generally, world welfare-improving. Besides static
effects (trade creation/trade diversion), regionalism has dynamic effects as
well (Baldwin and Venables, 1995; Srinivasan, 1997). Hence, regionalism
might affect welfare through the traditional trade effects (the allocation of
resources), accumulation effects (economies of scale) and the location effects
(agglomeration).
The gravity model of international trade explains trade volumes; however,
regionalism has been a fertile domain for its application. Its empirical and
recent theoretical strengthening has made it an appropriate research tool to
47
estimate trade flows. The gravity model is used to evaluate various aspects
of regionalism. A first branch of literature evaluates the trade effects (trade
creation/trade diversion effects) of RTAs (Acharya et al., 2011; Aitken, 1973;
Baier and Bergstrand, 2007; Bergstrand, 1985; Brada and Méndez, 1985;
Carrere, 2006; Egger, 2004; Endoh, 1999; Frankel et al., 1995; Krueger, 1999;
Magee, 2008; Soloaga and Winters, 2001). Another branch of literature uses
gravity model to estimate the trade potentials associated with RTAs (Baldwin,
1994; Brulhart and Kelly, 1999; Egger, 2002; Hamilton and Winters, 1992;
Nilsson, 2000). A third branch of literature examines the “natural trading
partner” hypothesis (Dhar and Panagariya, 1999; Frankel, 1998; Hassan,
2001; Sharma and Chua, 2000). A fourth branch of literature tests the national
borders effects in explaining regional trade patterns (Anderson and van
Wincoop, 2003; Evans, 2000; McCallum, 1995). A final branch of literature
estimates the “domino effect” of RTAs i.e. the response of non members when
a RTA is formed (Greenaway, 2000; Sapir, 2001).
The objective of this study is to explain the determinants of trade in ECO
region with emphasis on the impact of regional integration (ECO) on trade. A
gravity model is empirically tested with panel data for a sample of 34 countries,
the ten members of ECO and twenty four as their main trading partners all over
the world for a period of 32 years. The panel data framework helps to unravel
the time invariant country-specific effects and to capture the relationships
among the relevant variables over time. We used the pooled OLS, the random
effects, the fixed effects and the Poisson pseudo-maximum likelihood
(PPML) estimations. The results show that the economic sizes of origin and
destination countries and distance between them determines trade. We also
find common language, contiguity; common religion and landlockness to be
important determinants of trade flows. Importantly, the variable of interest the
ECO is positive and significant in all the four specifications, implying that the
ECO membership promote trade in the region.
AN OVERVIEW OF INTERNATIONAL TRADE IN ECO REGION

The international trade of the region is dominated by Turkey, Iran,
Kazakhstan and Pakistan, which explain more than 80 percent trade (87
percent imports and 82 percent exports) of the region. Turkey alone has been
accounting for more than fifty percent of the total regional imports since mid
1990s. In the first half of last decade, almost fifty percent exports of the region
were contributed by Turkey. In 2011, Turkey, Iran, Kazakhstan and Pakistan
accounted for 54.1 percent, 14.7 percent, 11.1 percent and 8.0 percent imports,
while 37.8 percent, 21.3 percent, 18.1 percent and 5.8 percent exports of the
region respectively. The share of Azerbaijan in total regional exports is also
expanded from 1.1 percent in 1996 to 9.2 percent in 2011.
48
Table (1): Trade of ECO countries (% of region)

Countries IPMORTS EXPORTS
1992 1996 2000 2004 2008 2011 1992 1996 2000 2004 2008 2011
AFG - - -
Table (1):2.3
Trade 1.5
of ECO0.0 - (% of-region)-
countries 0.9 0.5 0.0
Countries
AZE 3.4 1.8 IPMORTS
1.9 3.3 3.0 3.7 5.6 1.1 1.9 EXPORTS
2.3 8.1 9.2
IRN 1992
15.1 1996
16.8 2000
16.4 2004
18.1 2008
12.2 2011
14.7 1992 26.1
21.3 1996 21.6
2000 20.0
2004 16.02008 21.32011
KAZ
AFG -23.7 -7.7 8.3
- 9.9
2.3 12.8
1.5 11.1
0.0 23.9- 8.4- 9.7 - 12.30.9 19.20.5 18.1 0.0
KGZ
AZE 3.41.4 1.1
1.8 0.6
1.9 0.6
3.3 1.2
3.0 1.2
3.7 1.1
5.6 0.6
1.1 0.51.9 0.52.3 0.7 8.1 0.7 9.2
PAK
IRN 12.6
15.1 13.8
16.8 10.1
16.4 7.5
18.1 10.1
12.2 8.0
14.7 10.9
21.3 12.1
26.1 9.3
21.6 8.320.0 5.316.0 5.8 21.3
TJK
KAZ 0.3
23.7 0.8
7.7 0.8
8.3 0.8
9.9 1.0
12.8 0.9
11.1 0.2
23.9 0.9
8.4 0.89.7 0.712.3 0.219.2 0.2 18.1
TUR 34.9 51.3 57.0 53.5 53.4 54.1 29.7 44.3 50.3 50.1 43.9 37.8
KGZ 1.4 1.1 0.6 0.6 1.2 1.2 1.1 0.6 0.5 0.5 0.7 0.7
TKM 1.5 1.8 2.2 2.1 2.0 3.2 2.8 2.0 2.6 2.3 3.1 3.5
PAK 12.6 13.8 10.1 7.5 10.1 8.0 10.9 12.1 9.3 8.3 5.3 5.8
UZB 7.1 4.8 2.7 2.0 2.9 3.0 4.5 4.4 3.2 2.6 3.1 3.3
TJK 0.3 0.8 0.8 0.8 1.0 0.9 0.2 0.9 0.8 0.7 0.2 0.2
Source: World Development Indicators, WB
TUR 34.9 51.3 57.0 53.5 53.4 54.1 29.7 44.3 50.3 50.1 43.9 37.8
TKMThe trade
1.5 as1.8 percentage
2.2 of regional
2.1 2.0 GDP 2.8
3.2 has been2.0 oscillating
2.6 2.3 between
3.1 60
3.5
toUZB
90 percent 7.1 for last
4.8 two
2.7 decades.
2.0 The
2.9 percentage
3.0 4.5 of trade
4.4 to
3.2 GDP
2.6 also
3.1differs
3.3
from country
Source: to country.
World Development In 2011,
Indicators, WB Kyrgyzstan reported 139.1 percent trade to
its GDP, followed by TurkmenistanTable (2): Trade of ECO117.9 percent.
countries Azerbaijan 87.0 percent,
(% of GDP)
Tajikistan
Countries 73.6
1992percent,
1994 Kazakhstan
1996 1998 66.82002
2000 percent,
2004 Uzbekistan
2006 2008 59.1
2010 percent,
2011
Iran 52.9 percent, Turkey 50.4 percent and Pakistan 27.8 percent trade of
AFG - - 79.9 77.2 96.4 92.2 107.8 91.9 63.2 69.0 0.0their
respective
AZE GDPs. 140.8 55.4 85.1 77.2 77.4 92.8 121.5 105.3 89.2 73.9 87.0
IRN 41.1 43.4 35.8 29.3 40.1 49.3 55.0 56.9 54.3 48.6 52.9
Table (2): Trade of ECO countries (% of GDP)
KAZ
Countries 149.3 1994
1992 84.2 71.3
1996 65.2
1998 105.7
2000 94.0
2002 96.42004 91.6
2006 94.4
2008 73.2
2010 66.82011
KGZ
AFG -83.2 73.8
- 87.3
79.9 94.5
77.2 89.4
96.4 82.9
92.2 93.8
107.8 120.8
91.9 146.1
63.2 141.4
69.0 139.10.0
PAK
AZE 37.9
140.8 35.3
55.4 38.3
85.1 34.0
77.2 28.1
77.4 30.5
92.8 30.3
121.5 38.4
105.3 36.7
89.2 32.373.9 27.887.0
TJK
IRN 22.2
41.1 97.7
43.4 156.6
35.8 106.9
29.3 199.7
40.1 141.6
49.3 128.2
55.0 80.3
56.9 88.7
54.3 76.348.6 73.652.9
TUR 31.7 41.7 49.4 41.5 43.2 48.8 49.7 50.3 52.2 48.0 50.4
KAZ 149.3 84.2 71.3 65.2 105.7 94.0 96.4 91.6 94.4 73.2 66.8
TKM 105.3 170.3 150.0 103.5 176.4 122.5 121.2 108.0 104.4 106.3 117.9
KGZ 83.2 73.8 87.3 94.5 89.4 82.9 93.8 120.8 146.1 141.4 139.1
UZB 70.2 37.3 61.9 45.3 46.1 60.2 72.9 68.6 84.3 61.8 59.1
PAK 37.9 35.3 38.3 34.0 28.1 30.5 30.3 38.4 36.7 32.3 27.8
ECO 68.2 63.9 81.6 67.5 90.3 81.5 87.7 81.2 81.4 73.1 67.5
TJK 22.2 97.7 156.6 106.9 199.7 141.6 128.2 80.3 88.7 76.3 73.6
TUR 31.7 41.7 49.4 41.5 43.2 48.8 49.7 50.3 52.2 48.0 50.4
TKM 105.3 170.3 150.0 103.5 176.4 122.5 121.2 108.0 104.4 106.3 117.9
UZB 70.2 37.3 61.9 45.3 46.1 60.2 72.9 68.6 84.3 61.8 59.1
ECO 68.2 63.9 81.6 67.5 90.3 81.5 87.7 81.2 81.4 73.1 67.5
1
As trade is the highest priority of ECO. However, intra-regional trade
lingered below average considering the huge regional potential. The ratio of
intra-regional trade to overall regional trade has been remained in single digit
for the most part of the ECO history. The share of intra-regional trade varies
from country to country. In 2011, Afghanistan accounted for 52.3 percent,
1
49
followed by Tajikistan 50.0 percent, Kazakhstan 24.5 percent, Uzbekistan

23.6 percent, Kyrgyzstan 18.2 percent, Azerbaijan 7.2 percent, Turkey 7.1
percent, Pakistan 6.8 percent, Turkmenistan 6.0 percent and Iran 4.7 percent
of their total trade.
Table (3): Intra-regional trade (% of total regional trade)
Countries 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
AFG Imp 18.0 16.5 20.5 16.8 27.6 37.9 32.7 30.9 50.8 56.2 50.7 51.9
Exp 38.0 39.7 31.0 73.6 89.4 80.9 66.9 73.4 56.9 64.8 66.7 59.0
Total 20.1 17.3 20.9 20.4 35.2 43.7 37.2 36.5 51.7 57.1 51.8 52.3
AZE Imp 22.0 31.3 29.3 22.0 20.0 19.7 18.9 17.8 16.6 17.9 18.4 17.9
Exp 8.7 4.9 7.8 8.1 15.0 19.1 15.3 28.7 3.0 3.1 3.2 3.2
Total 14.0 15.0 17.1 15.1 17.5 19.4 17.0 23.4 4.8 7.4 6.8 7.2
IRN Imp 5.1 4.1 3.8 4.8 4.3 4.4 5.1 5.1 5.1 6.2 7.6 6.6
Exp 3.2 3.2 3.4 3.6 2.4 2.7 2.6 2.4 2.4 3.6 3.7 4.0
Total 3.9 3.6 3.6 4.1 3.3 3.3 3.5 3.3 3.4 4.6 5.1 4.7
KAZ Imp 8.3 10.6 9.9 8.7 9.5 10.7 11.3 12.9 14.6 14.4 13.4 13.0
Exp 9.7 9.4 9.4 10.0 11.6 12.8 14.5 14.6 22.9 18.5 21.6 23.0
Total 13.2 15.3 14.6 13.7 15.3 17.1 18.6 20.2 26.0 23.7 24.2 24.5
KGZ Imp 34.1 38.6 36.2 34.1 31.7 24.6 16.9 17.9 16.1 17.8 18.2 15.0
Exp 30.4 25.2 22.2 19.9 22.0 29.0 36.8 37.5 29.8 23.5 17.2 24.3
Total 32.4 31.9 29.9 27.8 27.5 26.2 23.2 24.2 20.4 19.8 17.8 18.2
PAK Imp - 2.7 2.4 3.3 2.8 3.1 2.5 2.2 2.2 3.4 3.8 2.5
Exp - 3.0 4.3 6.3 6.3 10.6 9.5 7.7 9.2 12.5 11.9 13.8
Total 3.6 2.8 3.3 4.7 4.4 6.2 5.1 4.2 4.5 6.4 6.7 6.8
TJK Imp 26.4 25.6 24.8 24.1 24.5 23.0 21.8 20.4 18.0 17.7 - 50.0
Exp 16.0 19.6 19.9 22.6 18.1 19.2 24.0 24.1 22.9 19.6 - 50.0
Total 21.8 23.0 22.4 23.4 21.9 21.6 22.8 21.9 19.7 18.2 - 50.0
TUR Imp 2.8 3.0 3.0 3.9 3.3 4.3 5.8 5.8 6.0 4.3 6.3 7.2
Exp 3.1 3.1 2.9 3.3 3.5 3.6 3.9 4.4 4.7 5.8 6.7 6.9
Total 2.9 3.0 3.0 3.7 3.4 4.1 5.1 5.2 5.5 4.9 6.4 7.1
TKM Imp 2.2 2.8 2.0 2.2 2.0 1.6 1.2 1.4 2.3 4.2 3.4 3.8
Exp 2.6 2.7 2.5 2.5 2.2 2.2 2.6 2.7 3.7 3.6 3.4 4.4
Total 3.5 4.1 3.3 3.5 3.1 2.7 2.6 2.8 4.1 6.0 5.1 6.0
UZB Imp 6.8 7.5 10.9 13.6 12.2 12.7 15.0 15.9 17.4 13.1 17.8 17.5
Exp 13.6 15.0 21.8 27.3 24.4 25.4 31.4 29.0 22.3 14.6 25.1 27.8
Total 12.9 15.8 18.3 21.3 19.7 22.5 24.4 23.4 20.1 13.9 22.2 23.6
Source: United Nations Commodity Trade Statistics Database
The region has marvelous potential for better intra-regional trade,

however, collective efforts are required from member states to support
2
necessary regulatory framework for this purpose. The removal of tariff and
50
non-tariff barriers is necessary step to be taken for liberalizing and promoting

intra-regional trade. The member countries seem devoted to enhance intra-
regional, which is still below its potential (see Table 4). They have already
taken various initiatives to integrate the regional trade. The ECO member
states signed the ECO Trade Agreement (ECOTA) in July 2003 in Islamabad.
This preferential trade agreement provides fabulous prospects for expansion
of intra-regional trade. The member states agreed to implement the ECOTA
gradually over a period of 8 years. They decided to reduce tariffs to a
maximum of 15 percent over 80 percent of the goods traded through ECOTA.
The ECOTA is in the implementation phase and would help to enhance the
intra-regional trade. Concurrently, the member states are negotiating to enter
into a Free Trade Agreement (FTA) by the year 2015. Besides this, other
arrangements are also in consideration to enhance intra-regional like the ECO
Trade Facilitation Agreement, Mutual Recognition Agreement (MRA) in
standardization, Regional Agreement on Avoidance of Double Taxation, ECO
Agreement on Prevention of Corruption and Money Laundering and ECO
Agreement on Joint Promotional Activities. These initiatives would certainly
help in promoting intra-regional trade.
Table (4): Intra-regional trade (Million US$), 2011
AFG AZE IRN KAZ KGZ PAK TJK TUR TKM UZB
AFG Import - 71.0 582.0 333.0 0 878.0 227.0 138.0 353.0 732.0
Export - 0.0 20.0 1.0 0.0 181.0 5.0 11.0 4.0 0.0
AZE Import 0.0 - 160.5 217.3 0.9 3.0 2.8 1,302.4 12.0 50.6
Export 100.2 - 144.8 58.3 21.2 0.1 13.2 455.8 43.9 21.9
IRN Import 10.3 37.5 - 135.7 4.8 272.6 18.9 3,313.6 136.4 137.9
Export 2,253.1 464.4 - 84.5 40.1 659.5 195.0 1,431.1 532.4 76.3
KAZ Import 3.8 61.8 34.9 - 242.0 29.6 47.8 729.3 66.7 770.6
Export 333.8 237.6 1077.0 - 507.8 3.6 356.8 2574.4 116.3 1179.5
KGZ Import 0.0 11.2 10.2 411.4 - 3.5 1.0 117.1 2.5 84.3
Export 23.5 1.9 7.0 289.7 - 0.6 36.3 54.5 7.6 124.4
PAK Import 171.9 0.0 572.4 17.4 0.1 - 2.5 176.2 41.5 10.5
Export 2,335.0 0.0 162.0 8.1 0.7 - 0.7 906.2 1.9 3.5
TJK Import 39.0 22.0 162.0 123.0 64.0 12.0 - 75.0 113.0 64.0
Export 94.0 2.0 42.0 47.0 3.0 3.0 - 544.0 3.0 4.0
TUR Import 4.8 262.3 12,461.5 1,995.5 52.1 873.1 324.3 - 392.7 939.9
Export 276.0 2,064.9 3,590.5 948.3 180.6 213.7 172.7 - 1,494.0 354.7
TKM Import 2.2 73.2 181.7 39.5 9.2 4.4 13.4 506.4 - 70.7
Export 76.0 74.1 483.9 10.6 46.4 1.1 58.2 372.0 - 11.9
UZB Import 0.9 26.1 61.1 1,097.6 65.9 13.9 5.5 277.4 285.7 -
Export 797.7 34.1 378.4 1,673.2 94.2 9.2 119.0 910.2 168.6 -
51
Export 333.8 237.6 1077.0 - 507.8 3.6 356.8 2574.4 116.3 1179.5
KGZ Import 0.0 11.2 10.2 411.4 - 3.5 1.0 117.1 2.5 84.3
Export 23.5 1.9 7.0 289.7 - 0.6 36.3 54.5 7.6 124.4
PAK Import 171.9 0.0 572.4 17.4 0.1 - 2.5 176.2 41.5 10.5
Export İktisat İşletme
2,335.0 0.0 ve162.0
Finans 8.1
29 (343)
0.7Ekim- / October
0.7 2014
906.2 1.9 3.5
TJK Import 39.0 22.0 162.0 123.0 64.0 12.0 - 75.0 113.0 64.0
The ECO94.0
Export member
2.0 countries
42.0 have
47.0initiated
3.0 reforms
3.0 - in their
544.0trade3.0
regimes
4.0
to liberalize
TUR Import it4.8further. Only12,461.5
262.3 three member
1,995.5 countries
52.1 873.1 of324.3
ECO, namely
- Pakistan,
392.7 939.9
Turkey, and 276.0
Export Kyrgyzstan
2,064.9 have joined
3,590.5 WTO180.6
948.3 as a 213.7
member,172.7while - all other
1,494.0 ECO
354.7
member
TKM Importcountries
2.2 still
73.2 have the status
181.7 39.5 of9.2 an observer
4.4 13.4in the
506.4WTO.- As the 70.7
WTOExportimposes 76.0 low tariff
74.1 and non
483.9 tariff
10.6 obligations
46.4 1.1 to its
58.2 members,
372.0 and
- they
11.9
are abided
UZB Import by0.9 the rules
26.1set by the WTO.
61.1 1,097.6 The65.9tariff rates5.5
13.9 in some277.4ECO member
285.7 -
countries,
Export
especially
797.7
the
34.1
non members
378.4
of WTO
1,673.2 94.2
seem
9.2
rather
119.0
low
910.2
but high
168.6
non-
tariff barriers in these countries hinder trade flows and offset the positive
effects of low tariffs.
Figure (1): Tariff rate, all products (%), 2010 (Source: World Development Indicators, WB)
52
Table (5): Share of ECO Trade in Sample Countries’ Total Trade (% of Total Trade)
Countries 1980 1984 1988 1992 1996 2000 2004 2008 2011
Afghanistan - - - 32.4 29.5 20.1 35.2 51.7 52.3
Azerbaijan - - - 28.6 40.9 14.0 17.5 4.8 7.2
Austria 1.0 1.3 0.9 1.2 1.1 1.2 1.6 1.7 1.8
Belgium - - - - 0.80 0.97 1.15 1.24 1.43
Canada 0.2 0.3 0.2 0.3 0.3 0.2 0.3 0.6 0.8
China 0.6 1.0 0.8 1.1 1.1 1.4 1.7 3.1 3.2
Finland 1.1 0.7 0.3 0.7 1.0 1.2 1.5 1.9 1.5
France 1.0 0.9 0.6 1.1 1.2 1.5 2.1 2.4 2.8
Georgia - - - - 26.7 30.9 28.7 30.3 31.9
Germany - - - 1.9 1.8 1.7 2.2 2.2 2.4
Indonesia 0.1 0.2 0.5 0.7 1.1 0.8 1.1 1.6 1.8
Iran 2.5 3.1 3.7 4.2 3.8 3.9 3.3 3.4 4.7
Israel 0.3 0.3 0.3 0.6 1.0 0.7 2.6 3.0 3.0
Italy 1.1 2.7 1.3 2.0 2.1 2.4 3.0 3.8 4.8
Japan 2.5 2.0 1.0 1.5 1.0 1.0 1.4 1.8 1.3
Kazakhstan - - - 13.1 10.9 13.2 15.3 26.0 24.5
Kyrgyzstan - - - 46.7 45.4 32.4 27.5 20.4 18.2
Malaysia 0.6 0.9 1.0 0.8 0.7 0.5 0/8 1.3 1.4
Netherlands 0.6 1.9 1.0 1.2 1.0 1.00 1.2 1.3 1.4
Pakistan 3.3 4.7 2.2 2.4 2.9 3.6 4.4 4.5 6.8
Romania - - 9.1 9.7 5.5 5.4 7.3 9.2 7.7
Russia - - - 6.7 7.5 8.00 8.6 9.2 7.0
Saudi Arabia 0.7 1.2 1.1 1.0 1.00 0.5 0.7 0.6 0.6
India 7.5 2.5 1.3 2.2 2.2 1.8 1.1 4.6 2.9
Spain 2.9 3.8 1.1 1.0 1.3 1.6 2.1 2.6 3.0
Switzerland 1.0 1.2 1.0 1.0 1.1 1.0 1.4 1.5 1.8
Tajikistan 23.5 19.3 21.8 21.9 19.7 50.0
UAE 2.5 1.4 3.0 3.9 14.7 4.7 5.0 5.0 5.1
Turkey - 12.2 4.9 3.2 3.5 2.9 3.4 5.5 7.1
Turkmenistan - - - 3.0 3.2 3.5 3.1 4.1 6.0
Ukraine - - - 8.4 10.1 11.2 10.6 14.8 9.1
United Kingdom 0.9 1.0 0.9 1.1 1.1 1.1 1.6 1.6 1.9
USA 0.4 0.6 0.5 0.7 0.6 0.6 0.7 0.9 1.0
Uzbekistan 15.3 13.5 12.9 19.7 20.1 23.6
Unfortunately, the ECO has not been 4 analyzed intensively as compared

to other RTAs. Hence, the applied trade literature for ECO is rather sparse.
Application of gravity approach for ECO is also rather limited. No worthwhile
empirical studies exist to examine the impact of ECO on regional trade except
the study by Clarete, Edmonds and Wallackc (2003). They suggest that the
53
ECO has been efficient in concentrating trade among its members. Their
findings show that the ECO member countries have a tendency to trade more
extremely among themselves at the expense of trade with the rest of the world
(outside the bloc ). They show that intra-bloc trade in the region was higher
in 1995 and 2000 than would be expected if the countries were not members
of ECO.
Achakzai (2006) assessed the magnitude of potential trade flows between
Pakistan and the nine other member countries of ECO using a gravity
framework. The study explores that the intra-bloc trade had large potential for
Pakistan and as compared to its potential it obtained lower share. The results
from the gravity model confirm that ECO has a positive and significant impact
on intra-regional trade. However, he suggests low intra-regional trade in the
ECO region. Achakzai (2010) estimated a gravity model for 137 countries
using bilateral trade dataset for the year 2005. The study examines the level
of trade and whether the present level of trade is accounted for by regional
integration or unilateral liberalization. The findings of this study confirms
that trade between ECO countries was lower than predicted by the gravity
model. The results also confirm that the present level of trade is attributed
to regional agreements rather than unilateral liberalization. He suggests
larger scope for regional cooperation in the ECO region. Toosi, Moghaddasi,
Yazdani and Ahmadian (2009) uses a gravity approach to estimates the
impact of Economic Cooperation Organization (ECO) on Iranian agricultural
exports. Their findings show that the ECO has a positive impact on Iranian
agricultural trade.
Raballand (2003) applies a gravity framework to assess the impact of
land-lockedness on trade in the Central Asian States. The findings of the study
show that the land-lockedness constitutes a significant impact in the form of
transportation cost for exporters in Central Asia. Felipe and Kumar (2010)
evaluate the trade gains derived from improvements in trade facilitation in
Central Asia. They also study the relationship between bilateral trade flows
and trade facilitation. Trade facilitation is computed through the World
Bank’s Logistic Performance Index (LPI). Their findings indicate that there
are significant gains in trade in consequence of improving trade facilitation in
the region. These trade gains vary from 28% in the case of Azerbaijan to as
much as 63% in the case of Tajikistan. It helps to raise the intra-regional trade
to about 100%. They show that the increase in intra-regional trade comes
from improvement in infrastructure, logistics, customs and usefulness of
other border agencies.
Ekanayake, Mukherjee and Veeramacheneni (2010) evaluate trade effects
of the regional trade agreements (RTAs) in Asia and their effects on intra-
regional trade flows. They estimate the gravity model with annual data for
54
19 Asian countries to a sample of 64 countries for the period 1980 to 2009.

They use four dummy variables for membership in regional trade agreements,
namely Association of Southeast Asian Nations (ASEAN), Bangkok
Agreement (BA), Economic Cooperation Organization (ECO) and South
Asia Association for Regional Cooperation (SAARC) in the gravity model
to assess their impact on trade. Their results shows that dummy variables for
ASEAN, BA, and SAARC have the expected (positive) signs and they are
statistically significant. However, the dummy variable representing ECO has
the unexpected (negative) sign. They conclude that this may be due to the fact
that only 2 of the 19 Asian countries (sample countries) are members of ECO.
The present study is an endeavor to contribute to the rather sparse literate
on trade in the ECO region. To our knowledge, this is the first attempt to
estimate the impact that ECO has on trade in a panel data framework using
32 year long panel.
MATERIAL AND METHODS

The Gravity theory is probably the most successful warhorse for empirical
studies in international economies. It has been used extensively for explaining
trade flows for more than half a century since it was introduced by Tinbergen
(1962). The gravity equation has its origin in the Newtonian physics,
specifically in the law of universal gravity. By analogy to the physical theory
of gravity, it states that trade increases with size and proximity of the trading
partners. The standard gravity model simply formulized in the following
form:
Despite its empirical success, initially it lacked a robust theoretical

foundation. It has been widely criticized for this shortcoming. However, this
view is no longer prevalent, in light of several recent systematic efforts to
reinforce its theoretical (microeconomic) underpinnings. Its recent resurgence
has produced an extensive literature; which proves that it is derivable from
both the traditional and the new theory of trade in homogenous as well as
differentiated
Where goods.
denotes the fraction of income spent on country i’s products and is the
Tinbergen (1962) and Poyhonen (1963) first introduced the gravity model
importers
as a model of trade(identical
volumes.homothetic preferences
Linneman (1966) derivedexists everywhere)
the relationship anda Yj denot
from
partial equilibrium model, country
GDP) in importing while Leamer and
j. As the Stern (1970)
condition from a in
that income probability
country i must equ
model of transactions. However, the underlying features of trade theory,
which exports)
determine implies thatand volume of trade, were missing from these
pattern
early endeavors. A systematic approach has been adopted to overcome this
shortcoming in the late 1970s, beginning with Anderson (1979) and including
Bergstrand (1985, 1989), Helpman and Krugman (1985), Deardorff (1998),
55
Solving (3) for yields

Evenett and Keller (1998, 2002), Eaton and Kortum (2001) and Anderson and
van Wincoop (2003).
Anderson (1979) derives the gravity equation, using Armington
preferences, Armington (1969) as a modeling trick to derive a role for
transportation costs. The key assumption of this framework is that goods
are differentiated by place of origin. For negative effect of distance on
trade, transportation costs are modeled as “iceberg” fashion, assuming that
transportation costs and distance are similar. Bergstrand (1985, 1989) develops
the analysis further, associating gravity equation with simple monopolistic
competition model and Anderson and van Wincoop (2003) refine it further to
incorporate the “relative distance effect” which helps to solve the so-called
border puzzle. The Armington model as a foundation for the gravity equation
lacks the production side of the equation. The “new trade theory” removes
this shortcoming, providing a solid theoretical foundation for the production
side of the gravity equation. Helpman and Krugman (1985) address this, using
a monopolistic competition model (differentiated product framework) with
increasing returns to scale. Deardorff (1998) validates the gravity model from
traditional trade theories, showing how it can be derived from Heckscher-
Ohlin perspective. Evenett and Keller (1998, 2002) tried to derive gravity
model from several trade models, and found some relevance especially with
Heckscher-Ohlin and Increasing Returns to Scale model. Eaton and Kortum
(2001) implanted the equation in Ricardian framework with homogenous
goods and iceberg transportation costs.
Anderson (1979) derived gravity equation rearranging a Cobb-Douglas
expenditure system. Assuming each country is specialized in the production
of its own good (monopolistic competition), under this assumption, there is
one good for each country and no tariffs or transportation costs exists and to
have identical homothetic preferences. It is also assumed that zero balance of
trade to hold in each period, as in cross sectional analysis, prices are constant
at equilibrium level and units are opted such that they are all unity. The
equilibrium trade volume from country i to j at any time period t is thus
Where denotes the fraction of income spent on country i’s products and is the same
importers (identical homothetic preferences exists everywhere) and Yj denotes inc
Where denotes the fraction of income spent on country i’s products
and isGDP) inWhere
the same acrossdenotes
importing country
all the fraction
j. As
importers the of income
condition
(identical that spent on
income
homothetic incountry
countryi’s
preferences products
iexists
must equaland
sale
everywhere) and Yj denotes
exports)importers
implies income
(identical
that (real GDP)
homothetic in importing
preferences country
exists j. As the and Y d
everywhere) j
condition that income in country i must equal sales (sum of exports) implies
that GDP) in importing country j. As the condition that income in country i mu
exports) implies that
56
Solvingİktisat
(3) forİşletme ve Finans 29 (343) Ekim / October 2014
yields
Substituting from (4) into (2), we obtain

Where
Where isis world
worldincome
incomeandandit remains constant
it remains across
constant countries. The
across
Where is world income and it remains constant across countries. Th
countries. The of
logarithm natural logarithm
(5) provides of (5)
the basic provides
empirical the equation
gravity basic empirical gravity
as follows.
equation asWhere
follows.
logarithm of (5) provides theisbasic empirical gravity equation as follows.
world income and it remains constant across countrie
logarithm of (5) provides the basic empirical gravity equation as follows.
Where α = (−lnYW), and Dij is a vector of time-invariant variables such as
distance andαother
Where = (−lnY W), and
dummy Dij is a vector of time-invariant variables such as distance a
variables.
TheWhere α = model,
gravity (−lnYW),inand its Dmost
ij is a vector of time-invariant variables such as distance a
general form, explains bilateral trade
dummy variables.
flows (exports,
dummy imports,
variables.
Where total
α = (−lnY trade) from origin to destination as a function of
W), and Dij is a vector of time-invariant variables such as dista
economic sizes of both regions as well as distance between them, plus a set of
The gravity
dummy model, in its most general form, explains bilateral trade flows (exports, impo
variables.
dummy variables.
The Generally
gravity model, in its the
mostpopulation with
general form, GDP is
explains used as
bilateral explanatory
trade flows (exports, impo
variable in the
trade) fromgravity
origin toframework,
destination as when the aim
a function of is to estimate
economic sizesthe aggregate
of both regions as well a
exportstrade) from
(Endoh,
The origin
2000),
gravity towhereas
model,destination as ageneral
when
in its most function of
one isform, economic
interested
explainsinsizes of both
traderegions
estimating
bilateral as well a
the (exports
flows
exports for trade)
specific products, the GDP per capita 5is used
from origin to destination as a function
along with GDP for
5 of economic sizes of both regions as
this type of analysis (Berstrand, 1989).
Following, Deardorff (1998), we model exports as5 a function of income
and population in the origin and destination countries and the distance
between them. To capture the geographical, regional and cultural effects, we
incorporate a set of dummy variables in the basic gravity equation. These
variables are common language, contiguity, common religion, landlockness
and the most important ECO membership. After this augment, the gravity
equation, finally retain the following form for estimation.
WhereWhere
o = 1,…,n denotes the origin,
o = 1,…,n denotes the origin,
d = 1,…,n denotes the destination,
d = 1,…,n denotes denotes
t = 1,…,T the destination,
the time,
EXPdenotes
t = 1,…,T
odt
is the
the value
time, of exports from origin to destination in time t,
EXPodt is the value of exports from origin to destination in time t,
57
GDPot is the Gross Domestic Product of origin country in time t,
GDPdt is the Gross Domestic Product of destination country in time t,
POP is the population of origin country in time t,
GDPot is the Gross Domestic Product of origin country in time t,

GDPdt is the Gross Domestic Product of destination country in time t,
POPot is the population of origin country in time t,
POPdt is the population of destination country in time t,
DISTod is the distance between origin and destination,
LANGod is a dummy with value 1 if origin and destination use the same
language and 0 otherwise,
CONTod is a dummy with value 1 if origin and destination share a land
border and 0 otherwise,
RELGod is a dummy with value 1 if origin and destination follow the
same religion and 0 otherwise,
ECOodt is a dummy with value 1 if origin and destination are members of
the ECO and 0 otherwise,
LOCKd is a dummy with value 1 when destination country is land locked
and 0 otherwise,
The contiguity or common border as proxy for “proximity” is commonly
used in gravity model.
The common language as proxy for cultural affinity is also common in
gravity literature. We use common religion along with common language
as proxy for cultural affinity because all ECO member states have the same
religion. Additionally, landlocked dummy is included as seven out of ten ECO
member states don’t have direct access to sea.
The variable of interest, Economic Cooperation Organization (ECO)
membership dummy is introduced to estimate the impact of regionalism
on trade in the region. It takes the value 1 whenever a member country
officially joined the ECO and 0 otherwise. The ECO was initially formed by
Iran, Pakistan and Turkey in 1985. Afghanistan and six central Asian states
Azerbaijan, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan and
Uzbekistan later joined the ECO in 1992. Therefore, the ECO dummy takes
the value 0 for all countries during the period from 1980 to 1984. Then it
takes the value 1 for Iran, Pakistan and Turkey during the period from 1985
to 1991. The ECO takes the value 1 for all 10 member countries from 1992
to onward.
As trade is expected to increase with economic size, hence the GDP
coefficients and are expected to be positive. The impact of population
on trade is, however, not straight forward. Therefore, population coefficients
and are expected to have ambiguous signs. The coefficient on exporter
population may be negatively or positively signed (Oguledo and Macphee,
1994), it depends on whether the country exports less when it is big
(absorption effect) or whether a bigger country exports more than a smaller
country (economies of scale), the coefficient on the importer population,
58
also has ambiguous signs, for similar reasons (Martinez-Zarzoso, 2003;

Martinez-Zarzoz and Nowak-Lehmann, 2003). The population of the trading
partners impact the trade flows negatively (Aitken, 1973; Blomqvist, 1994;
Linnemann, 1966; Matyas, Konya and Harris, 1997). Contrary to these
findings, Brada and Mendez (1983) show that population variable has positive
impact on trade flows. Frankel, Romer and Cyrus (1996) show that population
variable has negative impact on the exporting country and positive impact
on importing country. The distance coefficient is expected to be negative,
as in the gravity framework, distance is used as proxy for all possible trade
costs. The dummy variable coefficients on common language , contiguity
and common religion are all expected to be positive since all these
variables facilitate trade. However, the coefficient on land locked dummy
is expected to be negative as trade costs are increased if origin or destination
is a landlocked country. The coefficient on ECO membership dummy ,
which is the variable of our interest, may have positive or negative signs. A
positive sign will indicate that the ECO is a trade creating block, while the
negative sign will suggest that the ECO is a trade diverting RTA.
The gravity model is estimated for a 32 year long panel (1980-2011) of 34
countries (10 member states of economic cooperation organization, and 24 as
their main trading partners all over the world). The complete list of countries
in the sample is provided in appendix Table (10). We have an unbalanced
panel with 29064 observations as the data for some years is missing. It is
natural, that many countries do not trade with each other. Hence, the zero-
valued observations are very common in bilateral trade data. The number
of zeros in our data set is 1645 out of 29064 total observations, which is
about 5% of total observations. The exports data are obtained from the
United Nations Commodity Trade Statistics Database. The nominal data (in
terms of US dollar) are available annually for each county. We use Standard
International Trade Classification Revision 2 (SITC 2) because for our sample
the data for period 1980-2011 are only available in this classification. The
data for explanatory variables, the gross domestic product and the population
are available at World Economic Outlook Database, International Monetary
Fund. Data about the physical distance between two countries (capital cities)
in kilometers come from the Centre d’Etudes Prospectives et d’Informations
Internationales (CEPII). The dummy variables like common language,
contiguity, and landlockedness with values 0 and 1 are also taken from the
CEPII.
RESULTS AND DISCUSSION

We estimate gravity model for the period 1980-2011 for 34 countries.
For estimation purpose, we use the Pooled Ordinary Least Square (pooled
59
OLS), the Fixed Effects Model (within transformation model), the Random
Effects Model (GLS) and the Poisson Pseudo-Maximum Likelihood (PPML)
estimates. The pooled OLS estimate is simply pooling of the data assuming
that the intercept and the slopes do not vary across units or over time. Hence
pooled OLS estimation provides consistent and efficient estimates only if
the above assumption holds true. However, avoiding country specific time-
constant characteristics seems irrational. For presence of the individual
effects, we use two diagnostic tests: the F-test and the Breusch Pagan (1980)
LM test. If the significance of individual effects is proved, the pooled OLS
estimates are no more consistent and efficient. Hence, we apply two methods:
the fixed effects estimation and the random effects estimation for estimating
unobserved effects. Finally, we conduct Hausman (1978) test to check
whether the fixed effects or the random effects estimates are preferred in our
case. The test compares the fixed effects (OLS) and the random effects (GLS)
estimates utilizing the Wald statistic. The basic idea of the test relies on the
fact that under the null hypothesis of orthogonality both OLS and GLS are
consistent, while under the alternative hypothesis GLS is not consistent. Silva
and Tenreyro (2006) suggest estimating the gravity equation in multiplicative
form using Poisson Pseudo-Maximum Likelihood (PPML) estimation to deal
with the problem of heteroscedasticity and zeros better. The PPML estimator
is now very commonly used in the literature, and it is therefore important to
ensure that results obtained using OLS are robust to their application. Results
are reported in Tables (6) to (8).
60
Table (6): The results of estimation (basic gravity model) using Pooled OLS, REM, FEM, PPML
and PPML-FE
Dependent variable: Ln EXPod and EXPod for PPML
Variables POLS REM FEM PPML PPML-FE

LnGDPo .9366*** 1.0709*** .9858*** .6978*** .6754***
*** ***
LnGDPd .7869 1.0095 1.0983*** .8328*** .8237***
LnPOPo .3156*** .2232 ** .2596 .1064*** .1296***
LnPOPd .0708** .0054 .6694*** .0174** .0248**
*** ***
LnDIST od -1.0495 -1.2773 … -.8302 *** -.9851***
Constant 16.0922 *** 16.7253*** 3.7836*** 18.3391 *** 17.5038 ***
F-test (FE) … … 23.81*** … …
***
B-P LM test (RE) … 84887.38 … … …
Hausman test … … 78.57*** … …
R-sq: within … 0.1412 0.1418 … …
R-sq: between … 0.3695 0.2884 … …
R-sq: overall 0.2642 0.2620 0.2123 … …
R-sq: Pseudo … … … 0.8443 0.8456
Log P-Likelihood … … … -2.8631 -2.8790
F-test 2087.07 *** … 1153.73 *** … …
2 ***
Wald chi … 5192.04 … 14882.11*** 13541.34***
Exporter FE No No No No Yes (within)
Importer FE No No No No Yes
Time FE No Yes Yes Yes Yes
Country Pair FE No No Yes No No
Observations 29064 29064 29064 29064 29064
***, **, * significant at 1%, 5% and 10% level respectively
Table (6) presents the estimated coefficients for the basic gravity model.
We can see all the parameters have the expected signs. The coefficients on
origin and destination incomes LnGDPo and LnGDPd are positive as expected
for all estimators. The coefficient on origin and destination population LnPOPo
and LnPOPd are also positive for all estimators. The coefficient on distance
LnDISTod is negative. The results confirm that the gravity model perfectly
explains the trade flows for the sample used; exports are directly related to
economic size (income and population) and inversely related to distance.
It is notable that the Poisson model fits the data much better than does
the OLS model. The R2 for the PPML is around 84 per cent, compared with
26 per cent for OLS. Since the set of explanatory variables is the same in
both specifications; this difference indicates that the change in estimator is
important in order to pick up significant features of the data. The coefficient
estimates are considerably different under PPML compared with OLS. In
7
particular, the coefficient on distance LnDISTod under PPML is smaller in
absolute value compared with OLS. This result is typical of Poisson gravity
regressions, and mainly reflects the impact of heteroskedasticity on the
original OLS estimates (Santos Silva and Tenreyro, 2006). The estimated
61
coefficients are a bit sensitive to the inclusion of importer and exporter fixed
effects, which slightly reduce the magnitude of the GDP coefficients and
slightly increase the magnitudes of population and distance coefficients.
Table (7): The results of estimation (gravity model with ECO) using Pooled OLS, REM, FEM,
PPML and PPML-FE

LnGDPo 1.0407*** 1.0908*** .9845*** .6993*** .6802***
*** ***
LnGDPd .8909 1.0278 1.0970*** .8346*** .8133***
*** **
LnPOPo .2434 .1945 .2730 .1057*** .1431***
LnPOPd -.0015 -.0242 .6828*** .0184** .0395**
*** ***
LnDIST od -.8360 -1.0008 … -.8101 *** -.9511 ***
ECOod 2.7927*** 2.3998*** 1.4342*** 1.2643*** 1.2106***
*** ***
Constant 13.6025 14.2922 3.7572*** 18.3208 *** 16.8144 ***
F-test (FE) … … 22.40*** … …
B-P LM test (RE) … 83228.74 *** … … …
Hausman test … … 67.16*** … …
R-sq: within … 0.1406 0.1418 … …
R-sq: between … 0.3934 0.2776 … …
R-sq: overall 0.2765 0.2746 0.2062 … …
R-sq: Pseudo … … … 0.8443 0.8456
Log P-Likelihood … … … -2.8621 -2.8980
F-test 1850.83 *** … 923.30*** … …
Wald chi2 … 5272.34*** … 15016.20*** 14835.34***
Observations 29064 29064 29064 29064 29064
Table (7) presents the estimated coefficients for the gravity model
augmented with ECO membership dummy variable. We can see all the
parameters have the expected signs. The coefficients on origin and destination
incomes LnGDPo and LnGDPd are positive as expected for all estimators.
LnGDPo is almost similar in magnitude for the pooled OLS, the random effects
and the fixed effects estimations but considerably different for the PPML
estimation. Conversely, LnGDPd is almost similar in magnitude for the fixed
effects and the random effects estimations but different for the pooled OLS
and the PPML estimation. The coefficient on origin population LnPOPo is also
positive for all estimators; however, it is different both in magnitude as well
as in statistical significance. It is statistically significant at 1% level for the
pooled OLS and the PPML and 5% level for the random effects estimations,
but statistically insignificant for the fixed effects estimation. The coefficient
8
62
on destination population LnPOPd is negative and statistically insignificant for

the pooled OLS and the random effects estimation. Conversely, it is positive,
notably large in magnitude and statistically significant at 1% level for fixed
effects estimation. It is also positive and statistically significant at 1% level
for PPML estimation. The coefficient on distance LnDISTod is negative and
statistically significant at 1% level for the pooled OLS, the random effects
and the PPML estimations. It is dropped by the fixed effects estimation being
a time invariant variable. Finally, and importantly, regarding the variable of
interest (ECO), we can see that the coefficient on the (ECO) dummy variable
is positive and statistically highly significant for all estimators.
The comparison of results from basic gravity model and augmented
gravity model with ECO membership dummy shows slight changes in
estimated coefficients. The coefficients on origin and destination incomes
LnGDPo and LnGDPd are almost similar in magnitude for the random effects,
the fixed effects and the PPML estimations but different for pooled OLS.
The same is for the coefficient on origin population LnPOPo. The coefficient
on destination population LnPOPd is also similar for the fixed effects and
the PPML estimations; however, it is negative and statistically insignificant
for the pooled OLS and the random effects estimations. The coefficient on
distance LnDISTod is dropped in magnitude notably when we move from
basic gravity model to augmented gravity model with ECO membership
dummy for the pooled OLS and the random effects estimations.
63
Table (8): The results of estimation gravity model with all dummy variables using Pooled OLS,
REM, FEM, PPML and PPML-FE

LnGDPo .9997*** 1.0744*** .9845*** .6795*** .6647***
LnGDPd .8296*** 1.0466*** 1.0970*** .8134*** .8096***
*** *
LnPOPo .2126 .1581 .2730 .0931*** .0915***
LnPOPd -.0398 * -.0319 .6828*** .0545*** .0529***
LnDIST od -.5840 *** -.7623*** … -.5423 *** -.6974***
LANGod .3489** .1160 … .1761*** .1683***
CONTod 1.3732*** 1.4244*** … .6612*** .6426***
RELGod 1.5293*** .6904 * … .1509** .1494**
ECOod 3.8415*** 2.5756*** 1.4342*** 1.1941*** 1.1794***
* *
LOCKd -.2004 -.4808 … -.2608 *** -.3865***
Constant 12.3617 *** 12.3255*** 3.7572*** 17.1769 *** 15.3425 ***
F-test (FE) … … 22.40*** … …
B-P LM test (RE) … 80803.95 *** … … …
Hausman test … … 93.17*** … …
R-sq: within … 0.1405 0.1418 … …
R-sq: between … 0.4073 0.2776 … …
R-sq: overall 0.2863 0.2810 0.2062 … …
R-sq: Pseudo … … … 0.8643 0.8752
Log P-Likelihood … … … -2.4951 -2.6857
F-test 1165.30 *** … 923.30*** … …
2 ***
Wald chi … 5321.14 … 29648.55*** 27359.39***
Observations 29064 29064 29064 29064 29064
Table (8) presents the estimated coefficients for the gravity model with full
set of dummy variable. We can see all the parameters have the expected signs.
The coefficients on origin and destination incomes LnGDPo and LnGDPd are
positive as expected and statistically significant for all estimators. LnGDPo is
almost similar in magnitude for the pooled OLS, the random effects and the
fixed effects estimation but considerably different for the PPML estimation.
LnGDPd is almost similar in magnitude for the fixed effects and the random
effects estimations but different for the pooled OLS and the PPML estimations.
9
The coefficient on origin population LnPOPo is also positive for all estimators;
however, it is different both in magnitude as well as in statistical significance.
It is statistically significant at 1% level for the pooled OLS and the PPML
estimations and 10% level for the random effects estimation, but statistically
64
insignificant for the fixed effects estimation. The coefficient on destination

population LnPOPd is negative and statistically significant at 10% level for the
pooled OLS estimation. Conversely, it is positive, notably large in magnitude
and statistically significant at 1% level for fixed effects estimation. It is also
positive and statistically significant at 1% level for the PPML estimation.
However, it is negative and statistically insignificant for the random effects
estimation. The coefficient on distance LnDISTod is negative and statistically
significant at 1% level for the pooled OLS, the random effects and the PPML
estimations. However, it rises in magnitude notably when we move from the
pooled OLS to the random effects estimation and drops again for the PPML
estimation. It is dropped by the fixed effects estimation being a time invariant
variable.
The coefficients on all the dummy variables also have expected signs.
The coefficients on common language (LANG), contiguity (CONT), common
religion (RELG) are positive and the coefficient on land locked (LOCK) is
negative for the pooled OLS, the random effects and the PPML estimations.
However, the magnitudes as well as statistical significance differ when we
move across the pooled OLS, the random effects and the PPML estimations.
The fixed effects estimation, however, drops all time invariant variables.
Finally, and importantly, regarding the variable of interest (ECO), we can see
that the coefficient on the (ECO) dummy variable is positive and statistically
highly significant for all estimators. However, its magnitude falls notably
when we move from the pooled OLS to the random effects estimation. And
when we eliminate the unobserved individual effects entirely by using the
fixed effects estimation, the coefficient on ECO falls to about 1.43. It falls
further to 1.19 and 1.18 for the PPML and PPML-FE estimations respectively,
although it is still statistically significant.
The R2 values reported in Tables from (6) to (8), for the pooled OLS, the
random effects and the fixed effects estimations might seem rather low. But
it is not unusual, such low R2 values are typically observed in the panel data
specification. Since the panel data being a combination of cross sectional and
times series data, would have a large number of observations. Hence, a low
value R2 is normally expected in the panel data analysis. But these R2 values
are statistically significant, since the computed F values reported in Tables
from (6) to (8) are highly significant, as their corresponding p values are zero.
Tables from (6) to (8) present results for the pooled OLS, the random
effects model, the fixed effects model and the Poisson model. We have to
make a choice for a more efficient and consistent estimation. We start from the
pooled OLS estimation. Though, the results from the pooled OLS estimation
seem appealing. But, are they consistent? We consult the Breusch Pagan LM
test, and the F-test, we performed to check the poolability of the data. Results
65
from the Breusch Pagan LM test, reported in Tables from (6) to (8), show
that the individual effects are present. Then, we consider the F-test which
compares the unrestricted fixed effects model with the restricted pooled
model. Results from the test, reported in Tables from (6) to (8), confirm that
the individual effects are not equal as the null hypothesis is rejected. Hence,
we conclude that we cannot pool the data, and that the pooled OLS results
are inconsistent. So we have to choose a model which entertains individual
effects instead of the pooled model. Finally, we have to decide whether the
individual effects are fixed or random. Since, our sample (ECO member
states and their trading partners) is a predetermined drawn sample, which is
not randomly drawn from larger population, so the fixed effects model would
be a better choice. The Hausman test reported in Tables from (6) to (8), also
verify that the fixed effects model is more appropriate than the random effects
model. As a robustness check we use the PPML estimator.
As the gravity model is in the log form, so the coefficients reported in
Tables (6) to (8) are elasticities. The interpretation of results from Table (8)
is as; according to the pooled OLS estimation, with a 1% increase in the
origin and destination incomes, there would be a 1% and 0.83% increase in
the exports respectively. For populations, with a 1% increase in the origin
and destination population, there would be a 0.21% increase and a 0.04%
decrease in the exports respectively. For distance, with a 1% increase in
distance between origin and destination, there would be a 0.58% decrease in
export flows from origin to destination. The coefficient on common language
dummy variable has a magnitude of 0.35. For correct interpretation of this
coefficient we have to take its exponent, since the model is estimated in
log form and dummy variables have values 1 and 0. Hence, a value of 0.35
indicates that the origin and the destination countries with common language
have 42% {[exp (0.35) -1] * 100} more trade than countries with different
languages. The coefficient on contiguity with a magnitude of 1.37 indicates
that the origin and the destination countries sharing a common border have
294% {[exp (1.37) -1] * 100} more trade than two non adjacent countries. The
coefficient on common religion with a magnitude of 1.53 indicates that the
origin and the destination countries with common religion have 362% {[exp
(1.53) -1] * 100} more trade than two countries with different religions. The
coefficient on landlockness with a magnitude of 0.20 indicates that the trade
is 22% {[exp (0.20) -1] * 100} less if the origin or the destination country
don’t have direct access to sea. Finally, the coefficient on the ECO dummy
variable (variable of interest) with a magnitude of 3.84 indicates that intra-
ECO trade is about 4552% {[exp (3.84) -1] * 100}.
According to the random effects estimation, with a 1% increase in the
origin and destination incomes, there would be a 1.07% and 1.05% increase
66
in the exports respectively. For population, with a 1% increase in the origin

population, there would be a 0.16% increase in the exports. However, the
coefficient on destination population is statistically insignificant. For distance,
with a 1% increase in distance between origin and destination, there would be
a 0.76% decrease in export flows from origin to destination. The coefficient
on common language dummy variable is statistically insignificant. The
coefficients on contiguity and common religion dummy variables are positive
with 1.42 and 0.69 magnitudes respectively. The coefficient on landlocked
dummy variable is negative with a 0.48 magnitude. The coefficient on variable
of interest ECO is positive and statistically significant, with a magnitude of
2.58, indicating that the intra-ECO trade is about 1219% {[exp (2.58) -1] *
100}.
According to the fixed effects estimation, with a 1% increase in the origin
and destination incomes, there would be a 0.98% and 1% increase in the
exports respectively. For population, the coefficient on origin population is
statistically insignificant. For destination population, with a 1% increase in
the destination population, there would be a 0.68% increase in the exports.
The distance and the dummy variables are dropped being the time invariant
variables. The coefficient on the ECO dummy variable (variable of interest)
with a magnitude of 1.43 indicates that the intra-ECO trade is about 318%
{[exp (1.43) -1] * 100}.
The interpretation of the coefficients from the PPML estimate is
straightforward, and it follows exactly the same pattern as under the OLS
estimate. Though the dependent variable for the PPML estimate is specified as
exports from origin to destination (EXPod) in levels rather than in logarithms,
the coefficients on any explanatory variable entered in logarithms can still be
interpreted as simple elasticities. The coefficients on explanatory variables
entered in levels are interpreted as semi-elasticities, as under OLS estimate.
The coefficient on ECO with a magnitude of 1.19 and 1.18 for PPML and
PPML-FE estimations respectively, implying that a 10 percent increase in the
ECO would increase the exports by 12 percentage points. The coefficient on
ECO can be interpreted in another way. Since the magnitude of ECO dummy
variable is 1.19 (PPML) controlling for importer and exporter effects. At
the mean value of ECO (which is approximately 0.01), PPML generates an
elasticity of 0.01. To illustrate the economic significance (or insignificance)
of these numbers, the PPML estimate implies that, as a result of an increase
in ECO from its mean value to one standard deviation above the mean
(0.01+0.10=0.11), bilateral trade should increase by 1% (=0.01×1×100%).
In terms of standard deviations, this estimate indicates that a 1-standard
deviation increase in ECO from its mean value would lead to a 1.19 standard
deviation increase in the exports.
67
The results from Tables (6) to (8) for the pooled OLS, the fixed effects
and the random effects show that the income elasticities (exporter, importer)
are close to unity as envisaged by the theory. The magnitude of the coefficient
on exporter income is greater than that for the importer. It indicates that
the income elasticity of bilateral trade is more elastic with respect to the
exporter’s income than it is to the importer’s income; hence, it underscores
the importance of production capacity of a country in fostering exports. The
coefficient on exporter’s population is positive signed for all specifications.
The positive sign shows that country size is directly related to its trade.
Bigger countries export more than smaller countries (economies of scale).
The bigger counties are more likely to experience economies of scale and
to develop comparative advantage in their export industries than smaller
countries (Krugman, 1980; Venables, 1987). The coefficient on importer’s
population is negative signed but statistically insignificant for the pooled OLS
and the random effects estimations. It is positive and statistically significant
for the fixed effects and the PPML estimations. As the positive sign shows
that country size is directly related to its trade. Bigger countries have a larger
capacity to absorb imports than smaller countries (Krugman, 1980; Venables,
1987). It indicates an uneven distribution of gains from RTAs in favor of the
larger countries that will industrialize rapidly. The distance has a negative
effect on exports in all the models estimated. It provides strong support for
the hypothesis that transportation and other distance and time related costs
are an important determinant of trade flows as predicted by the theory. The
common language, common religion and contiguity have positive effects on
exports, indicating that the cultural affinity and the proximity ease trade. The
landlockness has a negative effect on exports, showing that no direct access to
sea reduces trade. Finally, the regional integration (ECO) has a positive effect
on exports, confirming that the ECO membership foster intra-regional trade.
The variable of interest ECO with a magnitude of 3.84 in the pooled OLS
estimation is dropped to 2.58 in the random effects estimation and to 1.43
in the fixed effects estimation. The drop in coefficient on the ECO dummy
variable is consistent with the idea that regional trade agreements (RTAs)
are unlikely to be purely exogenous. The motives behind the formation of
RTA may cause the endogeneity problem. According to the “natural trading
partner” hypothesis, a RTA is likely to be formed between counties who
already trade more with each other. In this typical case, the RTA dummy may
correlate with the error term, implying that the unobserved individual effects
of country pairs explain why they trade more with each other. The omitted
variable bias may also create endogeneity problem. This problem arises when
some political characteristics of RTA are omitted in the regression. The fixed
effects model eliminates all the time invariant unobserved effects so the
68
coefficient on ECO dummy variable drops to 1.43.

Our results are supported well by those obtained by Achakzai (2006 and
2010), Acharya et al. (2011), Aitken (1973), Baier and Bergstrand (2007),
Bergstrand (1985), Carrere (2006), Clarete et al. (2003), Egger (2004), Frankel
et al. (1995), Ghosh and Yamarik (2004), Lee and Shin (2006), Magee (2008),
Martinez-Zarzoso (2003), Martinez-Zarzoz and Nowak-Lehmann (2003),
Raballand (2003), Silva and Tenreyro (2006), Soloaga and Winters (2001)
and Toosi et al. (2009).
CONCLUSION
This study was aimed to explain the determinants of trade in the ECO
region, with particular emphasis on ECO (intra-bloc) trade effects. The gravity
model with panel data specification is analyzed for this purpose. We use four
specifications: the pooled OLS, the fixed effects model, the random effects
model and the Poisson model to estimate the gravity model. The above four
specifications generate rather interesting results. The magnitude as well as
statistical significance of the estimated parameters varies across the above
proposed specifications. The Poisson model fits the data much better than does
the OLS model.
Our findings show that the trade in the ECO region is determined by the
income and population of origin and destination countries and the distance
between them. Besides these core gravity variables, we also consider the role
that common language, contiguity, common religion and landlockness play
in explaining bilateral trade flows. Our results also confirm the importance of
these variables in determining trade in the region. Importantly, the variable of
interest ECO is positive and statistically significant in all the four specifications,
suggesting that the ECO membership fosters trade in the region.
The following policy implications can be drawn from our analysis. First,
to promote regional trade, the removal of tariff and non-tariff barriers as well
as facilitation of customs crossings are necessary steps to be taken. Second,
as seven out of ten member states are landlocked, this geographical nature
demands for better transit facility and improved transportation infrastructure
for enhancing regional trade.
As it is clear, the advantage of contiguity, cultural affinity, regional
potentials and formation of regional bloc (ECO) can be enjoyed fully if steps
are taken to facilitate trade at regional level. The ECO member states have all
ready initiated in this direction, the ECO trade agreement (ECOTA) is in the
implementation phase now. It would help to liberalize and open up regional
trade. The member states are negotiating now to establish a Free Trade Area
in the region by the year 2015. So the regional trade would be expected to
enhance in the coming years.
69
There are some possible ways to extend this research further. An aspect of
future research may involve estimating the impact of ECO on each member
state separately. Another aspect of research can be to investigate the impact of
ECO on trade in agriculture, industry and services sectors and so on. Finally,
it would be interesting to investigate the growth (welfare) effect of the ECO
on its member states.
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74
APPENDIX: Descriptive statistics, list of countries in the sample and year of entry of member
countries in the ECO.
Table (9): Descriptive Statistics of the Gravity Model

Series Observation Mean Std. Dev. Minimum Maximum
LnEXPod 29064 17.69086 5.393971 0 26.59195
LnGDPod 29604 5.129497 2.092576 1.23443 9.622054
LnPOPod 29604 3.46288 1.525597 0.00995 7.206467
LnDISTod 29604 8.175395 0.834878 5.153484 9.703274
LANGod 29604 0.071566 0.257773 0 1
CONTod 29604 0.084778 0.278556 0 1
RELGod 29604 0.142582 0.349652 0 1
ECOod 29604 0.063377 0.243645 0 1
LOCKd 29604 0.223369 0.416511 0 1
Table (10): List of countries in the sample

Afghanistan* Kyrgyz Republic*
Austria Malaysia
Azerbaijan * Netherlands
Belgium Pakistan*
Canada Romania
China Russia
Finland Saudi Arabia
France Spain
Georgia Switzerland
Germany Tajikistan*
India Turkey*
Indonesia Turkmenistan*
*
Iran Ukraine
Israel United Arab Emirates
Italy United Kingdom
Japan United States
Kazakhstan* Uzbekistan*
(*) ECO member states
10
75
Table (11): Year of entry of member countries in the ECO

ECO Member States Year of Entry
Afghanistan 1992
Azerbaijan 1992
Iran* 1985
Kazakhstan 1992
Kyrgyz Republic 1992
Pakistan* 1985
Tajikistan 1992
Turkey* 1985
Turkmenistan 1992
Uzbekistan 1992
*Founding members of Regional Cooperation for
Development (RCD), the successor organization of
ECO founded in1964
11
76
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Does regionalism promote intra-regional trade? The case of ECO

Article in İktisat İşletme ve Finans · October 2014

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Does regionalism promote intra-regional trade?

Khadim Hussain (a) Jianhong Xue (b)

Received 11 September 2013; received in revised form 1 August 2014;

Özet. Finans Krizi Sırasında Türk Endüstrilerinin Risk Durumları

(a) Khadim Hussain is an Assistant Professor at Department of Economics, Mirpur Univer-

The Economic Cooperation Organization (ECO) is an inter-governmental

AN OVERVIEW OF INTERNATIONAL TRADE IN ECO REGION

Table (1): Trade of ECO countries (% of region)

followed by Tajikistan 50.0 percent, Kazakhstan 24.5 percent, Uzbekistan

The region has marvelous potential for better intra-regional trade,

non-tariff barriers is necessary step to be taken for liberalizing and promoting

Unfortunately, the ECO has not been 4 analyzed intensively as compared

19 Asian countries to a sample of 64 countries for the period 1980 to 2009.

MATERIAL AND METHODS

Despite its empirical success, initially it lacked a robust theoretical

Solving (3) for yields

Substituting from (4) into (2), we obtain

GDPot is the Gross Domestic Product of origin country in time t,

also has ambiguous signs, for similar reasons (Martinez-Zarzoso, 2003;

RESULTS AND DISCUSSION

Variables POLS REM FEM PPML PPML-FE

Variables POLS REM FEM PPML PPML-FE

on destination population LnPOPd is negative and statistically insignificant for

Variables POLS REM FEM PPML PPML-FE

insignificant for the fixed effects estimation. The coefficient on destination

in the exports respectively. For population, with a 1% increase in the origin

coefficient on ECO dummy variable drops to 1.43.

Press: 128-151. http://dx.doi.org/10.1093/0195130529.003.0008

memberships: an empirical analysis”, Journal of International Economics 76(2): 384-399.

Studies 45: 520–536. http://dx.doi.org/10.1057/palgrave.ces.8100031

Table (9): Descriptive Statistics of the Gravity Model

Table (10): List of countries in the sample

Table (11): Year of entry of member countries in the ECO

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