Trade integration of Central and Eastern European countries : lessons from a gravity model

This paper analyses the rapid trade integration of the Central and Eastern European countries (CEECs) with the euro area in the past ten years and draws implications for further integration. We use as benchmark an enhanced gravity model estimated for a large sample of bilateral trade flows across 61 countries since 1980. We show that a careful examination of the model's fixed effects is crucial for the proper interpretation of the results: simply extracting the predicted values of the regression ("in-sampleʺ) as commonly done in the literature leads to distorted results as it fails to properly account for the transition process. We therefore propose a two-stage out-ofsampleʺ approach. The results suggest that trade integration between most of the largest CEECs and the euro area is already relatively well advanced, while some Baltic and South Eastern European countries still have significant scope for trade integration