Explaining Ethiopia's Foreign Trade Potential: A Dynamic Gravity Approach

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Addis Ababa University


Towards improvement of Ethiopia's poor performance in the global trading system, the main objective of this paper is to estimate trade potential of the country with major trade partners around the world. The gravity model of trade has been duly employed for the purpose. For the sake of plausible results, recent innovations of the gravity model are incorporated as well. Specifically, a dynamic gravity approach based on a panel dataset of sample countries was estimated by System GMM estimators to first analyze the pattern of (basic vs export) trade flows. The coefficients obtained are then used to predict the basic trade and export trade potentials for Ethiopia. As a result, we found that the dynamic gravity model fits the data well, indicating the presence of hysteresis in trade. Besides, the traditional gravity variables are all significant with anticipated signs. The last major finding of the study is that considerable part of the country's potential trade has remained unrealized. The magnitude of trade potential was found the highest with Asian, European and then African countries as a continent. The study recommends that export diversification which advances the narrow export dependency, improvement of infrastructure which reduces transaction costs, and bilateral trade negotiations stepping up the current status of the external sector are the necessary steps to exploit Ethiopia's untapped trade potential. Key Words: Dynamic Gravity Approach, Ethiopia, Trade Potential.



Dynamic Gravity Approach, Ethiopia, Trade Potential