A Model of Bilateral Trade Balance: Extensions and Empirical Tests

A re-thinking and clear understanding of the factors underlying a country's balance of trade position is needed as the global trade regime becomes more liberalized. The relationship between the overall trade balance and its determinants as propounded in the standard models may not necessarily be the same with the bilateral trade balances. This study has developed a model of bilateral trade balance that captures the effects of all factors influencing trade balance as suggested by elasticity, absorption, and monetary approaches and the popular Gravity Model with some extensions. Specifically, the present paper postulates that the relative factors determine the trading pattern, and hence the trade balance of a country in bilateral trade with partners while in the earlier models absolute factors determine the trade balance. Using standard panel data techniques the model is empirically tested and the results show significant effects of all the relative factors on the bilateral trade balance of Bangladesh in trading with her partners. The robustness check of the model ensures the validity of the specification.