Brexit imageGravity theory of trade

Jan tinbergen imageIn attempting to understand the pattern of trade in a globalised world, economists tend to use the gravity model. This was first presented in 1962 by Jan Tinbergen, who proposed that the size of bilateral trade flows between any two countries can be approximated by employing the ‘gravity equation’, which is derived from Newton’s theory of gravitation. While planets are attracted to each other in proportion to their sizes and proximity, so too are countries.

Relative size is determined by current GDP, and economic proximity is determined by trade costs – the more economically ‘distant’ the greater the trade costs. 

The gravity model suggests that relative economic size attracts countries to trade with each other while greater distances weaken the attractiveness. Initially, the gravity model was seen as an empirical one, without any particular grounding in trade theory, but the widespread adoption of the gravity model to explain patterns of trade has been seen by economists as a significant development on previous theoretical models.

These include the Ricardian model, that explain trade patterns in terms of differences in the distribution of technology, and the Heckscher-Ohlin model that relies on differences in factor endowments among countries as the basis for trade. In these pre-gravity models the size of an economy was not considered significant.

The stability of the gravity equation and its ability to explain bilateral trade flows led to the development of theories that could incorporate the model.  The gravity model is now seen at the workhorse of trade theory, and especially in terms of forecasting the impact of changes in trade policy on trade costs. The model is flexible in that 'distance' between countries can include a range of relevant variables, including cultural and political differences between trading nations.

The Gravity model has provided the underlying theoretical framework for  forecasting the effects on trade flows as a result of the UK leaving the EU (Brexit).

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