Bangladesh's Trade with Asia: What Do Gravity Models Tell Us?

Abstract

External trade has played a crucial role in Bangladesh’s strong economic growth and structural transformation, in the backdrop of rising prosperity in Asia as a whole. This paper examines the effect of national incomes and trade costs of three key Asian sub-regions—which “powered” the overall growth and prosperity in Asia as a whole—on Bangladesh’s external trade. The paper used the gravity model of international trade to test its validity in explaining Bangladesh’s trade with the sub-regions. Alternative empirical specifications of the model were econometrically estimated. The parameter estimates indicate that the central hypothesis of the gravity model is valid, i.e., trade between any two countries is directly proportional to their national incomes and inversely proportional to their trade costs. In line with these predictions, Bangladesh’s trade with the three key Asian sub-regions were found to be positively related to their GDPs and inversely related to trade costs. The predictive power of the estimated gravity models is also high. The statistical tests relevant to the econometric estimation of the specified model and the data used were conducted to ensure that the parameter estimates were robust. The model thus provides a solid basis for forecasting medium-term trade growth with the key Asian sub-regions, and hence it has a value to Bangladesh’s planners and policymakers. The results also imply that Bangladesh should pay greater attention to reviving trade (and industry) reforms to benefit from growing prosperity in its continental neighbourhood.

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