Trade Creation and Trade Diversion for Mercosur

This paper describes the process of economic integration of Mercosur and discusses the trading patterns before and after the formation of the trading bloc. It also evaluates the effects of Mercosur on the trade volumes of the member countries, analyzes their bilateral trading patterns, and estimates the extent to which this bloc has resulted in either trade creation or trade diversion in each country. The objective was to provide insights into patterns of trade creation and trade diversion within Mercosur. A modified gravity model was used to measure the bilateral trade flows between 13 countries consisting of the Mercosur members and selected non-member countries. Countries include the four Mercosur members, the remaining six countries in South America-Bolivia, Chile, Colombia, Ecuador, Peru, and Venezuela-Japan, the United States, and the European Union. It considers the effects of international trade related variables such as GDP, population, imports, exports, distance, and adjacency variables. The major explanatory variables determining the scope of regional economic integration are GDP, population size, distance and adjacency. The gravity model also estimates the trade creation and trade diversion in the Mercosur countries. Spatial autocorrelation in the data is tested through the use of Moran's I in order to validate the spatial independence assumptions of the gravity model. The results of the analysis provided evidence of trade diversion in Brazil, Paraguay, and Uruguay. There is neither trade creation nor trade diversion in Argentina. The Moran's I indices for the four Mercosur members indicate no specific trend towards greater geographic concentration in the Mercosur trade patterns. The results, showing a non-significant spatial dependence in the residuals, suggest gravity model 1 adequately accounts for the major sources of variation in trade share.