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Understanding the gravity model of trade

Summary:
The gravity model of trade tells us that the amount of trade between two economies depends upon their relative sizes and the distance between them. This is an observation and one that holds up rather well in the real world. However, it is vital to grasp that distance here is not geographic distance, it’s economic distance.Economic here meaning things like, obviously, tariff barriers and transport links but also such intangibles as culture, language and so on over and above that mere geographic distance. Which is where Phillip Inman goes slightly wrong:A deal with Australia is not significant in itself: Truss admits it would boost Britain’s economy by just £500m over 15 years, or 0.02% of GDP – figures that explain why most economists agree trade is something that happens with nations close

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The gravity model of trade tells us that the amount of trade between two economies depends upon their relative sizes and the distance between them. This is an observation and one that holds up rather well in the real world. However, it is vital to grasp that distance here is not geographic distance, it’s economic distance.

Economic here meaning things like, obviously, tariff barriers and transport links but also such intangibles as culture, language and so on over and above that mere geographic distance. Which is where Phillip Inman goes slightly wrong:

A deal with Australia is not significant in itself: Truss admits it would boost Britain’s economy by just £500m over 15 years, or 0.02% of GDP – figures that explain why most economists agree trade is something that happens with nations close at hand or that share strong cultural ties. Almost 50% of trade remains with the EU despite Brexit, and the US is the largest single destination for UK goods.

As Daniel Hannan points out those cultural ties with Australia are fairly strong:

Even so, it is extraordinary that anyone should object to restoring our pre-EEC relationship with Australia, a country to which we could hardly be closer in commercial practices, legal norms, accountancy systems, political institutions, regulatory standards, professional qualifications, wage levels or sentimental links.

Quite a free trade deal would simply be removing some of that economic distance deliberately added by the EU’s tariff walls, wouldn’t it?

If we are, as Inman suggests, to consider cultural ties as being an important part of this process - which they are - then it’s difficult to think that those ties of the UK with Bulgaria, say, or Finland, are closer than those with Australia or New Zealand.

Tariff barriers are deliberate additions to economic distance and why do we want to make those foreigners further away than they need be?

There is also the point that the aim and idea of trade is to gain access to those things which foreigners do better or cheaper than we do. Which gives us our reaction to this:

Farmers would accept a larger volume of imports from any deal, but they want the protection offered by some form of permanent quota. They are concerned by briefings last week that the UK will offer Canberra a transition to tariff- and quota-free access after 15 years, saying that would eventually result in cheaply produced food flooding on to the market, and pushing down prices.

Cheap food, eh? That’s your complaint - and?

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Tim Worstall
Tim Worstall is a British-born writer and Senior Fellow of the Adam Smith Institute. Worstall is a regular contributor to Forbes and the Register. He has also written for the Guardian, the New York Times, PandoDaily, the Daily Telegraph blogs, the Times, and The Wall Street Journal. In 2010 his blog was listed as one of the top 100 UK political blogs by Total Politics.

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