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For purposes of this paper, the Mashreq countries include Egypt, Israel, Jordan, Lebanon, and Syria; data limitations keep us from including the West Bank and Gaza in our sample.
The paper was prepared while Rodolphe Blavy was working as a summer intern in the Fund’s Middle Eastern Department in the summer/fall of 2000. I wish to thank colleagues in the Middle Eastern Department for valuable comments. Ms. Ilse-Marie Fayad, Ms. Aminata Toure, and Farhan Hameed provided valuable research assistance.
The contraction of trade relative to GDP in Egypt (and Lebanon, where factors related to the war are an obvious explanation) basically reflect unchanged exports while, with high domestic inflation and an unchanged exchange rate, GDP rose sharply in foreign currency terms.
There is substantial trade between Israel and WBG, which however is not recorded as foreign trade in the DOT statistics underlying the analysis of this paper. Trade between the WBG and other countries outside Israel is not recorded in DOT statistics on foreign trade of Israel.
The use of one variable for the size of the country (a population or economic size variable) and of another variable for the level of economic development (typically the level of GDP per capita) is rejected because of the multicollinearity that would arise between the two variables.
Another method is to regress one of the variables on the remaining ones. In our model, the resulting R2 is lower than 50 percent, and the presence of multicollinearity is again rejected.
A fourth factor, the lack of product complementarity has sometimes been quoted as a limit to intra-regional trade in the Mashreq. The relative similarity of resources (oil and agricultural products) and factor endowments (unskilled labor) limit trade flows based both on product differentiation and on comparative advantage (see for example Yeats, 1996). However, it appears difficult to break each bilateral trade flow (i.e., each of the 6,644 recorded flows) along product lines, to account for product complementarity. Moreover, theoretical discussions on the role of product complementarity in the Mashreq have been inconclusive. Fischer (1993) and others argue that lack of product complementarity may be a limit to bilateral trade. On the other hand, Havrylyshyn (1997), using a complementarity index, suggests that product complementarity in the Mashreq compares favorably with other regions. Further research may attempt to develop measures of product complementarity between countries to assess its impact on trade.
The Trest variable that we include in the model specification is a “threshold” variable. However, even though the use of threshold variables may be inadequate, the alternative is to use dummy variables accounting for each threshold; in our case nine dummies are required for each level of trade restriction, except for the base level. For this reason, we decided here to use the Trest variable as such, because its levels measure directly quantitative levels (how much trade restriction in the reporting country). The underlying assumption is that the increment in bilateral trade at each threshold is the same. Testing for standard assumptions of linear regressions, we found that both linearity and normality conditions were satisfied for the Trest variable.
Such high elasticities may seem surprising. They are however comparable with coefficients estimated by Bergstrand (1985) for multi-industry trade flows (Bergstrand, 1985, p. 148-151), and by Bergstrand (1989, p. 479), for exchange rate deviations.
The risk of multicollinearity in the variables between the two dummies is limited because intra-regional trade is a very small fraction of total trade for the Mashreq.
Again, we test for the presence of multicollinearity in the Mashreq and IntMashreq dummy variables. The fact that the dummy for international trade in the Mashreq includes intra-regional trade (for example, trade between Egypt and Jordan is recorded with a “1” for both dummies) may reduce the explanatory power of the regional trade dummy. The correlation between the two dummies nevertheless appears limited (the coefficient of correlation amounts to 15 percent), and multicollinearity does not appear to be a concern in our specification.