International Journal of Economy, Management and Social Sciences, 3(1) January 2014, Pages: 113-117

TI Journals

International Journal of Economy, Management and Social Sciences

ISSN
2306-7276

www.tijournals.com

Irans Regional Trade and Real Exchange Rate

(Gravity Panel Data Models)
Nasser Ali Yadollahzadeh Tabari *1, Shaghayegh Haghighat 2
1
2

Department of Economics, Babol Branch, Islamic Azad University, Babol, Iran.

Department of Management, Babol Branch, Islamic Azad University, Babol, Iran.

AR TIC LE INF O

AB STR AC T

Keywords:

This study analyzes the relationship between bilateral trade and regional trade and increase in the
Rials real exchange rate on this trade by using the gravity model. The analysis is based on panel
data covering separately bilateral trade and regional exports and imports between Iran and 45 Asian
countries from 2001 to 2011. The first analysis is based on Pooled EGLS Fixed Effect Model and
the second analysis utilizes the pooled EGLS Random Effect Model.The results from the two
approaches show that Irans trade balance is positively related to regional trade and Irans imports
and exports increased by 6.4%,16% for every 10% increase in GDP in the 45 Asian countries. The
effect of increase in Rials real exchange rate is asymmetric and tends to increase imports and
reduce exports. This means that 10% increase in the Rials real exchange rate increases 7.1% of
regional imports and reduces 16% of regional exports. We conclude that increase in the regional
trade with all regional blocs in Asia leads to increase in Iran's foreign trade and an increase in the
Rials real exchange rate reduces trade imbalance for Iran.

regional imports
regional exports
gravity model
real exchange rate

2014 Int. j. econ. manag. soc. sci. All rights reserved for TI Journals.

1.

Introduction

According to a lot of academic, business and policy communities, globalization appears to be the best to describe todays economic
environment in the world. In a loose sense, globalization means that international trade is not choked by man-made restrictions and that
most countries exploit and gain from cross-border transactions. In a strict sense, globalization implies that transactions among residents of
distant countries are just as likely and intense as transactions among residents of neighboring countries or among residents of communities
located inside a country [7]. The literature on regionalism versus multilateralism is growing as economists and political scientists grapple
with the question of whether regional integration arrangements are good or bad for the multilateral system? [11]. Regionalisms direct effect
of multilateralism is important, but possibly more so is the indirect effect it has by changing the ways in which groups of countries interact
and respond to shocks in the world of economy. Regionalism, by allowing stronger internalization of the gains from trade liberalization,
seems likely to facilitate freer trade when it is initially highly restricted. So too does the view that regionalism is a means to bring trade
partners to the multilateral negotiating table because it is essentially coercive [25]. The Characteristics of the Irans political geography in
the region between Central Asia, the Caspian Sea, Persian Gulf and West Asia, always have created the potential of regional economic goals
in the foreign policies. It is clear that for achieving the world trade and increasing its share in this market due to population and economic
power, Iran must mak a suitable space to attract foreign investment and follow up a membership in the WTO, into the core of these
interactions. In addition to the development of bilateral economic relations, one of the most advanced options in front of Iran is the gain of
membership of regional trade and multilateralism to expand trade and interaction with economic [20]. The other side of trade costs
stemming from geographic distance and formal trade barriers is an important obstacle to international trade. However, observed trade costs
do not fully explain international trade flows, as trade also involves unobserved costs stemming from cultural and institutional differences
between countries. Because of these differences, firms have incomplete information about foreign markets and cultures, which causes
additional trade costs related to information collection and contract negotiation and enforcement [15]. The question that arises is how there
is a relationship between regionalism and bilateral trade? The most basic model of bilateral trade flows is the Gravity Model pioneered
by Tinbergen (1962). Since then, there have been numerous derivations of the model and it is central to the empirical study of trade flows
and related issues in international economics. They relate trade flows to country characteristics and trade costs. The relationship in Isaac
Newtons famous law arises when size proxies the country characteristics and distance proxies the costs to trade. In structural gravity
models, country characteristics are explicit functions of preferences, technologies, and endowments [24]. For example, [12], [6], [1], [8],
[21] to review bilateral trade flows by using the gravity model and its derivatives. [5], [9] used the gravity model to examine the effects of
regionalism on world trade. In this article by using panel data econometric techniques to analyze the role of regional trade (Asian partners
of Iran) on irans bilateral trade balance by the gravity model during the years 2001-2011, and the variant considered in this gravity
* Corresponding author.
Email address: nasertabari@yahoo.com

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Int ernational Journal of Economy, Mana ge ment and Soci al Sci ences , 3(1) January 2014

equation , in this article focus on Rials real exchange rate. The hypotheses of this paper include: 1. Regional exports, has made a
significant with Irans Bilateral trade. 2. Significant relationship exists between the increase in Rials real exchange rate and the regional
exports. 3. Regional imports have made a significant role in Irans bilateral trade. 4. Significant relationship between the increase in Rials
real exchange rate and the regional imports exists. 5 Increase in Rials real exchange rate has the same effect on regional exports and
imports in Iran. Section 2 will review the literature on Irans regional trade. In Section 3, we will present the gravity model .Section 4 will
discuss the methodology of panel data. Section 5 will discuss the data used in the estimation. Section 6 will present the primary results of
the gravity model and the last section will present conclusions and suggestions.

2.

Study literature

In terms of Geography, Iran is a country within the five sub-regions (Indian subcontinent, Central Asia, the Caucasus, the Persian Gulf and
the Middle East) and has its own opportunities and a challenges with15 neighboring countries. Iran's geopolitical ability and strategic
capacity can play a role of a bridge in the peripheral areas and can provides free access to landlocked ountries for the sea and surrounding
subsystems together [16]. For example, in 2009 the amount of Iran trade with Asian countries rose up to more than 75%, and 25% of this
rise came from other countries in 2012 and also trade turnover with EU countries of Europe decreased from 27.8 billion euros to 12.8
billion euros in 2011. In the meantime, the Asian countries, including Japan, South Korea, India, and China significantly increased oil
imports from Iran [14].In addition most studies about regionalism and its relationship with bilateral trade flows in Iran by using the gravity
model, take into account specific areas in Asia. For example, [19] examined bilateral trade flows between Iran and ECO in 2003 by gravity
model and have concluded that Iran and eco states had greater convergence than the euro member states due to the same economic, social
and religious ties. [18] by using a generalized gravity model to evaluate the effects of economic integration plan on the balance of payments
of developing selected countries gave the model estimated by using panel data for the period of 1971-2006 for eleven countries, including
Iran, the Middle East and East Asia countries. The results show that the elasticity of imports and exports relatied to GDP is respectively,
0/43and 0/86. Thus, the long-term orientation has a positive trade balance and the design of economic integration improves the long-term
balance of payments situation. [13] have estimated a generalized gravity model for the data used in this study, which included 26 members
of the three organizations (ECO, ASEAN and GCC), within the period of 2002 -2006 in the fall and the results show that all the three of the
selected regions in this period, have faced with trade diversion (increased trade, lower costs with non-member countries). [17] sought to
answer the question of whether the regional blocs in Central Asia, including Iran, India, Pakistan, Sri Lanka, Bangladesh, Afghanistan and
Nepal will be successful or not. The formation of regional blocs will affect the flow of bilateral trade of these countries they said. What
effects will block its trade with other countries? They have achieved these results with using theoretical concepts and convergence of
regional and gravity model with establishment of a regional bloc in Central Asia and could increase bilateral trade between the countries
with the establishment of a regional bloc in Central Asia that will increase trade (exports and imports) with other countries in the world. In
the estimated gravity model independent variables explain about 0/85 of the dependent variables changed (bilateral exports). [22] studied
the formation of a regional trade agreement between Iran and the Middle East, including the expansion of trade and income integration to
estimate a gravity model of bilateral trade flows by using effective economic factors , non-commercial trading partner, Characteristics of
them such as economic structure, level of political relations and cultural exchanges, religion, writing and speaking, manners, human
development index, geographic distance and also taking into consideration the integration of countries into a regional union. The study used
data from twelve countries economic trading partners of Iran in the period 1993 to 2003. So the model has estimated by using panel data.
The results show that economic integration among countries can increase the volume of bilateral trade flows, but they will not cause
income convergence among them. Due to the fact that economic growth in Asia has led this continent to become the center of world affairs
and the twenty-first century is called the Asian century with 75% of international resources in Asia [23]. And because of Irans position in
the Central Asian region which is one of the most important regional and geo-strategic and geo-Cultural in the world [2], There is a need
for a more comprehensive study on Iran's relations with Asian countries which has not been studied with particular interest in this area.

3.

Gravity model

The gravity model is a widely used tool to estimate the bilateral trade flows between members the countries. Its concept is based on
Newtons law of gravity and it was firstly used by Tinbergen (1962). It relates the bilateral trade flows to GDP, distance, border and other
factors that affect the trade patterns. The standard gravity model postulates that the trade between the member countries is proportional to
the national income and inversely related to the distance which is a proxy for transportation cost and information cost because these costs
are reduced as geographical distances decrease. Other variables such as country size, common border, common language, population size,
infrastructure etc. are also included in the gravity model [1]. In the mathematical notation the simple gravity equation has the following
structure:
TTij=A

(1)

Where, TTij - total trade flows between country i and country j, i j Y ,Y - market size of Countries i and j, for instance given by their real
income, ij D - distance between counties i and j, A some constant gravity parameter.
Log-line arising yields the following equation:

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Internat ional Jour nal of Economy, Mana ge ment and Social Sciences , 3(1) January 2014

lnTTij = ln A + lnY i + lnY j - ln Dij (2)

The gravity model implies than that the larger, the more prosperous and the closer to each other are the two countries, the more they are
likely to trade [4]. In this paper regional exports and imports for the optimization gravity equation is estimated separately and the following
states:
Log(X-Rij) = 0 + 1log (GDPj ) + 2 log(REXij) + 3 log (POPij)+ it (3)
Log (M-Rij) = 0 + 1log (GDPj) + 2log (REXij) + 3 log (POPij) +it (4)
X-R ij: Stands for the export of Iranian exports to the region, which represents 45 Asian countries (Appendix I) on their business. This
variable shows Iranian exports in Asia from 2001 to 2011.
M-R ij: Stands for the import representing 45 Asian countries from importing Iranian side of the business. This variable shows Iranian
imports in Asia from 2001 to 2011.
GDPj :Per capita real output (GDP) of 45 Asian countries from 2001 to 2011. This variable indicates the size of the economy and shows the
economy's ability to produce.
REXij: Stands for the real exchange rate that represents the real exchange rate 0f Riyal and the real exchange rate of 45 busines Partners. It
is the focal and major variable of this empirical investigation.
POPij: It represents population of Iran and 45 Asian countries in the years 2001-2011. This variable can be indicative of the size of the
market and shows the size of each country.

4.

Panel data analysis

Traditionally, classical gravity models have been expressed as single equations using cross-sectional data to estimate trade flows between a
pair of countries for a particular period (one year). However, the panel data framework provides more useful information vis--vis singleequation models, and has become increasingly popular since it allows the study of a particular issue at multiple sites with periodical
observations over a defined timeframe. Several estimation techniques have been used while using the panel data approach. In particular, the
fixed effect and random effect models are the most prominent [10].
4.1 The Fixed Effect Model (FEM)
There are good reasons to argue that country-specific fixed effects are relevant when export or import effects (like tariff and non-tariff
barriers) or environmental" determinants that could drive or hamper trade flows (geographical, political or historical determinants) are
present. These factors are deterministically linked to the countries specific characteristics and cannot be considered as random. Besides, a
fixed effect (with) estimator - including a constant term with all the country-specific characteristics avoids misspecification problems due
to omitted variables [3]. The model can be written as:
yit=1i+2ix2it+ 3ix3it+uit (5)
The subscript i to the intercept term suggest that the intercepts across the individuals are different, but, each individual intercept does not
vary over time. The FEM is appropriate in situations where the individual specific intercept might be correlated with one or more
repressors. To take into account the differing intercepts, the use of dummy variables is the most common practice and, therefore, the
specification is known as the least-squares dummy variable (LSDV) model, which can be written as:
yit=1 +2D 2i+ 3D3i+ 4D4i+2xit++ 3it+ uit (6)
4.2 Random Effect Model (REM) or Error Components Model (ECM)
In contrast to the FEM, the REM assumes that the intercept of an individual unit is a random draw from a much larger population with a
constant mean. The individual intercept is then expressed as a deviation from this constant mean value. The REM has an advantage over the
FEM in that it is economical in terms of degrees of freedom, since we do not have to estimate N cross-sectional intercepts. The REM is
appropriate in situations where the random intercept of each cross-sectional unit is uncorrelated with the regresses. The basic idea is to start
with Equation (7). However, instead of treating 1i as fixed, it is assumed to be a random variable with a mean value of 1. Then the value
of the intercept for individual entity can be expressed as:
1i = 1 + i where i = 1, 2 n (7)
The random error term is assumed to be distributed with a zero mean and constant variance:
Substituting (8) into (7), the model can be written as:
yit = 1 +2 x2it + 3 x3it + i + uit = 1 +2 x2it + 3 x3it+ wit (8)
The composite error term wit consists of two components i is the cross-sectional or individual-specific error component, and uit is the
combined time series and cross-sectional error component, given that i, ~ (0, 2 ), xit~ (0, 2 u) where i is independent of the Xit [3].

5.

Data

We collected official bilateral trade data from 45 of Irans trading Asian partners since 2001 to 2011 from the annual statistics of the
Islamic Republic of Iran Customs Administration (IRICA). We also collected Per capita GDP in 45 Asian countries and the real exchange
rate of rial and the 45 countries and Population of Iran and these 45 countries from the World Bank Institute (WBI). We estimated
Equations 3 by using estimated generalized least squares method EGLS (Cross-section fixed effects) and Equations 4 by EGLS (Crosssection random effects).

Nasser Ali Yadollahzadeh Tabari and Shaghayegh Haghighat

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Int ernational Journal of Economy, Mana ge ment and Soci al Sci ences , 3(1) January 2014

6.

Summary of results

Table 1 summarizes results from the EGLS Fixed Effects (Cross) model. According to the estimates of the gravity equation for regional
exports the estimated coefficient of trading partners GDP is 1.6 and significant at 5% confidence level that showed a positive relationship
between the regional exports and bilateral trade of Iran. This result is consistent with Leander theory1 , on the other hand Iran's exports
increased by 1/6% for every 1% increase in GDPj. So the first hypothesis (Regional exports, has made a significant with Irans Bilateral
trade) is confirmed. The coefficient of REX of riyal and Irans 45 business Partners is estimated at -1.6 and significant at 5% level that
showed a negative relationship between REX ij and regional export.
The second hypothesis (Significant relationship between the increase in Rials real exchange rate and the regional exports) is confirmed.
This means that one percentage increase in the Rials real exchange rate reduces 1/6% of regional exports. The coefficient of population is
estimated at 0.60 but it is not statistically significant at 5% level. The adjusted R 2 coefficient is 0.86 and shows that about 86% of change
the dependent variables (regional exports) is explained by the independent variables in the model. F-statistic indicates the significance of
the overall model. Necessary action was taken to resolve the heteroskedasticity variance and autocorrelation.

Table 1, Pooled Regression Results for regional exports of Iran: EGLS with Asian partners (FEM)

Variable
C
Log(GDPj)
Log(REX ij)
Log (POPij)

Coefficient
0.65
1.60
-1.60
0.60

t-Statistic
0.12
11.52
-2.87
0.92

Prob
0.89
0.00
0.004
0.35

Weighted Statistics
0.86
57.69
0.00

Adj. R2
F-statistic
Prob(F-statistic)
Source: Authors estimates.

Table 2 summarizes results from the EGLS Cross-section random effects model. According to the estimates of the gravity equation for
regional imports the estimated coefficient of trading partners GDP is 0.64 and significant at 5% confidence level that showed a positive
relationship between the regional imports and bilateral trade of Iran. This result is consistent with Leander theory. on the other hand Iran's
imports increased by 6.4% for every 10% increase in GDPj and the third hypothesis (Regional imports, has made a significant relation with
Irans Bilateral trade) is confirmed. The coefficient of REX of riyal and Irans 45 business Partners is estimated at 0.71 and significant at
5% level that showed a positive relationship between REXij and regional import. The fourth hypothesis (Significant relationship between
the increase in Rials real exchange rate and the regional imports) is confirmed. This means that 10% increase in the Rials real exchange
rate increase 7.1% of regional imports. The coefficient of population is estimated at -0.69 but it is not statistically significant at 5% level.
The adjusted R2 coefficient is 0.32 and it shows that about 32% of change the dependent variables (regional exports) is explained by the
independent variables in the model. F-statistic indicates the significance of the overall model. According to the results of the two models,
there are a significant and negative relationship between REX ij and regional export and a significant and positive relationship between
REXij and regional import. Thus, the fifth hypothesis (Increase in Rials real exchange rate has the same effect on regional exports and
imports of Iran) is rejected.

Table 2, Pooled Regression Results for regional imports of Iran: EGLS with Asian partners (REM).

Variable
C
Log(GDPj)
Log(REX ij)
Log (POPij)
Adj. R2
F-statistic
Prob(F-statistic)

Coefficient
2.20
0.64
0.71
-0.69

t-Statistic
1.22
6.48
3.25
-1.004

Prob
0.22
0.00
0.0015
0.31

Weighted Statistics
0.32
22.07
0.00

Source: Authors estimates.

According to this theory, the same countries tend to trade with each other than dissimilar countries. Per capital income is one of the most important factors
that express the degree of similarity between the two countries, So Whatever GDP per capita countries are much closer together the amount of bilateral trade,
it would be more(Karimi Hsnyjh,2007).

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Internat ional Jour nal of Economy, Mana ge ment and Social Sciences , 3(1) January 2014

7.

Concluding remarks

This paper analyzes the role of regional trade in Irans trade balance and the impact of the Rials appreciation on regional trade with gravity
model. We used a fixed effects model to examine the export regional gravity equation and random effects model to examine the import
regional gravity equation. Our estimations revealed that Irans trade balance is positively related to regional trade. Empirical results imply
that an increase in GDP of 45 Asia countries will increase Iran's exports and imports. The effect of increase in Rials real exchange rate is
asymmetric and increases imports and reduces exports. Population variable does not have a meaningful and significant relationship with
Irans regional trade. Based on these results, we conclude that the increase in the regional trade with all regional blocs in Asia leads to
increase in Iran's foreign trade. Also increase in the Rials real exchange rate reduces trade imbalance of Iran.

Appendix I
Asian countries partners of Iran:
Afghanistan
Armenia
Azerbaijan
Bahrain
Bangladesh
Brunei Darussalam
Cambodia
China
Cyprus
Georgia
Hong Kong, China
India

Indonesia
Iraq
Japan
Jordan
Kazakhstan
Korea, Rep.
Kuwait
Kyrgyz Republic
Lao PDR
Lebanon
Macao SAR, China
Malaysia

Maldives
Mongolia
Myanmar
Nepal
Oman
Pakistan
Philippines
Qatar
Russian Federation
Saudi Arabia
Singapore
Sri Lanka

Syrian Arab Republic

Tajikistan
Thailand
Turkey
Turkmenistan
United Arab Emirates
Uzbekistan
Vietnam
Yemen, Rep

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