Income and Price Elasticities of Croatian Trade: A Panel Data Approach Vida Bobić

Introduction  Croatian economy characterized by pronounced external imbalances, as evidenced by a high current account deficit  Main cause of current account deficit is the large and growing merchandise trade gap  Paper focuses on trade elasticities, primarily those of income and prices  Sensitivity of trade flows to changes in other factors (exchange rate, tariffs, FDI) analyzed as well  Estimation of elasticity coefficients using dynamic panel data methods and sectoral data

Trade facts  Persistent trade deficits throughout the analyzed period  Comparison with peers – much more pronounced trade imbalace Imports and exports Coverage ratios (Share of exports in imports)

Trade modelling  Many ways to model trade, depending on data availability, level of aggregation, purpose of model, etc.  Most models based on imperfect substitutes model imports and exports are not perfect substitutes for domestic products no specialization of countries  Coefficients on the variables of interest can be interpreted as elasticities

Trade modelling (2)  Using disaggregate sectoral data and panel methods takes into account heterogeneity of the data, thus limiting aggregation bias  Use of dynamic methods allows for adjustment dynamics in the data – although coefficient on lag is of no interest in itself, including it allows for more consistent estimates of other parameters  Sectoral effects are removed by first-differencing the data  Estimation of the model by GMM (Arellano and Bond, 1991)  Lagged dependent and endogenous variables in this framework are instrumented with their lagged levels

Export and Import Functions  I i... imports  X i... exports  GDP... Croatian GDP  GDP*... world GDP  P Im i... import prices  P Ex i... export prices  P i... price of domestic products in the country  P i *... price of foreign products abroad  ER... nominal exchange rate  Tariffs i... import tariff rates  FDI i... foreign direct investment  i... groups of goods 1, 2,... 31, according to NCEA

Export and Import Functions (2)  Export and import volumes by sector, in tonnes  Croatian and world income – real GDP  Export and import prices – derived as unit values by sector  Exchange rate – nominal kuna/euro rate  FDI – cumulative value of inflows by sector  Tariff rates (imports) – derived from tariff income data, by sector

Estimation results - Exports  Income elasticity coefficient close to 2  Relatively low price effect, suggesting low sensitivity of export volume to changes in price  Exchange rate not significant

Estimation results - Imports  Somewhat higher income elasticity than for exports  Price effect lower than unity, but higher than for exports dependence on imports  Unlike exports, exchange rate significant  Effect of tariffs statistically significant, but very limited

Conclusion  Income effects dominant and stronger than price effects – implications of relation between income elasticities for exports and imports on GDP growth  Price effects relatively low for both exports and imports  Negligible effect of tariffs  Exchange rate effect not as important as expected, and only significant for imports – appreciation of the kuna in the analyzed period contributed to some degree to dynamic import growth