This chapter applies the gravity model approach to examine the trade creation and trade diversion effects in terms of total trade, export, and import for 86 countries over 1994-2018. To evaluate the possible difference between countries, the analyzing sample is divided into three groups: high income, upper middle, and lower middle income countries. Therefore, specific for each income level group, trade creation and trade diversion effects are estimated by Poisson pseudo maximum likelihood estimator. Moreover, along with this, the trade potential for each group and even for each country is calculated based on the estimated results. The results indicate that even in average, the country groups look like they reached their trade potential. The country-based analysis reveals that there is vital potential to expand trade relations. In this context, the findings point out the possibility of increasing income level by developing trade potential, especially in continuously rising globalization.
TopIntroduction
The end of World War II and the beginning of changes in the world economic order marked the beginning of globalization. There are many definitions for the term globalization (Potrafke, 2014). However, in general, globalization can be described as a multilateral process of the increasing interdependence of countries in the economic, political, cultural and, as the crisis it was demonstrated by the Covid-19 pandemic, also in health aspects. Moreover, with the end of the Cold War, the process of globalization has accelerated and has led to severe growth in trade, investment, travel, and migration. For example, during the 1990s, the volume of international export of merchandise goods raised more than 80 percent (Irwin, 2005). Naturally, the multifaceted process of globalization also has both positive and negative effects, which are reflected in the presence of defenders and opponents of globalization. This ambiguity of globalization, especially in terms of its influence on the development of international trade, has become a motivating fact for a considerable amount of research in this area. Simultaneously, such a controversial issue requires careful study and providing new evidence based on the analysis results using updated data.
Globalization can be defined and measured differently, depending on the area in which it is experienced. Concomitantly, economic globalization is often measured in the literature as an increase in international trade and investments (Brady, Beckfield, and Zhao, 2007). Since the focus of this study is foreign trade, this dimension of economic globalization is considered. Increasing economic globalization due to the liberalization in international trade also brings fiscal costs to the agenda. Because trade barriers, which are the essential factor for increasing trade, need to be reduced. However, the reduction of trade barriers brings with it severe fiscal costs. These fiscal costs constitute a severe obstacle to the public economy. Frey and Olekseyuk (2014) state that trade liberalization is beneficial, but the fiscal costs of reducing trade barriers are often neglected. Trade liberalization can cause loss of tariff revenues and economic and social problems. These effects may lead to the decision not to liberalize foreign trade, especially in developing countries. This situation is examined by Regan (2015) in terms of why governments with political aims make trade agreements. According to the mentioned study, if governments decide to liberalize trade through trade agreements, they will face various fiscal costs. Nevertheless, governments are less willing to spend and give up tariff revenues to give exporters subsidies. When the fiscal costs of trade liberalization are realized, Cagé and Gadenne (2018), examining how long the decline in income lasts in different historical periods, reveal that the fiscal cost of trade liberalization experienced by today's rich countries in the early stages of economic development was more negligible and shorter-lived than that experienced by developing countries. These findings show why it is difficult to take steps to liberalize trade in developing and transition economies from the fiscal context. Bansah and Mohsin (2021) examined the impact of loss in trade-related tax revenues due to trade liberalization on welfare through infrastructure funding. The authors conclude that fiscal costs may provide vital constraints for economic growth. Moreover, their findings reveal that as fiscal costs increase, it reduces the welfare rise that will occur due to trade liberalization. Therefore, the fiscal costs of various trade agreements/trade liberalization measures to increase bilateral trade constitute a severe obstacle to the public economy. In this context, it is crucial to investigate whether trade liberalization within the scope of economic globalization has created trade creation or trade diversion effects on the country's economy. Because while the world trade system is being reshaped through trade agreements, it creates different effects for different countries (Clausing, 2001).