Trade creation and trade diversion of regional trade agreements revisited: A constrained panel pseudo-maximum likelihood approach

For the estimation of structural gravity models using PPML with countrypair, exportertime and importer-time effects it proves useful to exploit the equilibrium restrictions imposed by the system of multilateral resistances. This yields an iterative projection based PPML estimator that is unaffected by the incidental parameters problem. Further, in this setting it is straight forward to establish the asymptotic distribution of the structural parameters and that of counterfactual predictions. The present contribution applies the constrained panel PPML estimator to reconsider the trade creation and trade diversion effects of regional trade agreements. Results show significant trade creation effects of RTAs ranging in between 8.7 and 21.7 percent in 2012, but also point to substantial trade diversion in the range of -14.4 and -5.8 percent. These counterfactual predictions account for adjustment in multilateral trade resistances. The quite large confidence intervals of counterfactual predictions seem to be an overlooked issue in the literature.