#1Papua New Guinea Global Trade Potential: Evidence from the Gravity Model Analysis. Lekima Nalaukai School of Accounting Finance & Economics The University of the South Pacific#2Contents ▸ Background and Introduction. ▸ PNG Trade Overview. ▸ Survey of Literature. Theoretical Justification. ▸ The Model. ▸ Data, Methodology and Model Configuration. ▸ Estimates. ▸ Trade Potential. ▸ Conclusion. ▸ Policy Suggestions.#3Background and Introduction Papua New Guinea (PNG) is the largest country and economy in the Pacific, representing 80% of the Pacific's economy and population. ▸ PNG's economy is expected to grow by 4.0 per cent in 2023, with non-resources and resources growth at 4.6 per cent and 2.0 per cent respectively. With the expansion of their mineral and energy exports from the last decade, they are expected to experience significant growth in total export values in coming years. There is a long historical background on the theories supporting the connections between trade and economic growth. (Romer, 1986; Lucas, 1988; Solow, 1994) all supported the theory that openness to trade propelled economic growth. ▸ The question that we attempt to answer is whether PNG can take advantage of their trade potential as they enter post-COVID with a promising mineral and energy sector. Using an augmented Gravity Model with OLS we attempt to investigate PNG's trade potential between 31 countries using cross section data.#4Papua New Guinea Trade Overview (WTO 2021) PNG is a low-income country (2021) (USD): GDP - $26,937 . Per Capita GDP - $2,898 CA Balance (% of GDP) - 22.0% . Trade (% of GDP) - 28.2% ▸ It is the largest country by geography, population and GDP in the Pacific with an estimated population of 10.1m in 2022. According to Lowly Institute, the population estimates varies between 9 to 12 million. ▸ Trade: . ● In 2021, PNG registered a trade-to-GDP ratio of 54.5%, and merchandise trade accounted for 92.9% of Papua New Guinea's total trade. (merchandise exports grew by 5.5% from 2017-2021) The services trade share of total trade by Papua New Guinea amounted to 7.1% in 2021 (services exports contracted by 3.7%, following a year of 68.1% decline in 2020).#5Papua New Guinea Trade Overview (WTO 2021) 2021 2010-2021 2020 2021 Million USD Value (Annual % change) Merchandise Exports f.ob 10, 433 6 -19 12 Merchandise Imports f.ob 3,024 Commercial Service Exports Commercial Service Imports 98 935 -9 7 9 9 -1 -19 -8 -9 -68 -4 -15 -32#6Papua New Guinea Trade Overview (WTO 2021) Top Exported Products Value % of Total Exports (USD) Mineral fuels including oil 5.9 b 50 Gems, precious metals $1.8 b 14.9 Ores, slag, ash $1.1 b 9.2 Animal/vegetable fats, oils, waxes $955.3 m 8.0 Nickel $665.5 m 5.6 Wood $627.4 m 5.3 Meat/seafood preparations $246.1 m 2.1 Coffee, tea, spices $206.2 m 1.7 Fish $165.1 m 1.4 Cocoa $93.8 m 0.8#7Papua New Guinea Trade Balances (ADB 2021) Papua New Guinea The Pacific Southeast Asia Developing Asia Fiji 2015 2018 2019 2020 2021 2016 2017 5,876 5,861 6,408 7,032 7,904 6,701 8,866 3,600 3,620 4,059 4,325 5,305 4,480 6,489 135,668 133,110 138,299 110,844 123,462 114,862 113,116 711,968 631,437 576,948 443,011 539,086 488,739 508,892 -967 -912 -996 -1,093 -1,320 -1,122 -920#8Papua New Guinea Trade Overview ▸ Major Trade Partners (2021): Year PNG Trade to the World Growth • China -25% of its exports and 24.7% of its imports. 2000 1092.21 -3.81% 2001 989.24 -9.43% 2002 1055.76 6.72% • Japan - 25.4% of exports and 4.3% of 2003 1200.71 13.73% imports by value were traded with. 2004 1425.82 18.75% 2005 1800.49 26.28% ● Australia; 2006 2098.09 16.53% 2007 2640.20 25.84% • Singapore; 2008 3112.58 17.89% 2009 3457.91 11.09% ● Taiwan, China; 2010 4568.47 32.12% 2011 6416.84 40.46% • The Republic of Korea; 2012 8110.53 26.39% 2013 6253.27 -22.90% • The Netherlands; 2014 5585.54 -10.68% 2015 4988.73 -10.69% Malaysia; 2016 4419.46 -11.41% 2017 4544.15 2.82% . India; and 2018 4793.11 5.48% 2019 4760.34 -0.68% • Indonesia. 2020 4144.20 -12.94%#9What are they doing? PNG's top 10 trading partners (2010-2020, cumulated) Medium Term Development Plan (2018-2022) - $7.8b investment plan. ▸ Trade policy review. ▸ Refocusing on the fiscal consolidation. ▸ Legal and Regulatory Framework. Investment and Competition Policy. ▸ Good Governance. ▸ Trade Related Infrastructure. ||| 2010-2020 (USD million) 2010-2020 (%) 2011 2015 2020 1 Australia 20,528.86 -26.63 27.15 -34.39 -22.34 2 China 7,589.86 161.77 28.4 55.45 15.12 3 Singapore 7,322.22 -29.87 55.49 -25.64 -30.73 4 Malaysia 4,565.50 11.97 167.05 -17.82 -30.16 5 Japan 2,536.24 -46.55 10.47 -4.7 8.01 6 Indonesia 2,027.27 -9.56 98.95 27.14 -9.11 7 United States 1,881.70 -67.40 58.6 44.86 -34.4 8 Thailand 1,767.96 -9.85 44.14 8.8 -17.27 9 New Zealand 1,626.15 -17.61 21.48 -15.86 -13.27 10 Italy 681.38 40.79 447.08 -24.18 -46.87 The World 58,584.64 -9.29 40.46 -10.69 -12.94#10Survey of Literature. There is a wide range of applied research where the Gravity Model is used to examine the bilateral trade patterns and trade relationships. Bergstrand 1985 and 1989, • Oguledo and Macphee 1994 • Frankel 1997 Karemera et al. 1999 . Mathur 1999, and • Sharma and Chua 2000, ▸ The Gravity Model were all used by the above authors to determine the aggregate bilateral trade and the product level trade. ▸ Other areas such as trade costs, non-tariffs barriers, regional integration etc were covered by these authors.#11Survey of Literature. ▸ Other trade related areas were covered by these authors: • Trade Costs: . • (Rose, 2000), (Harrigan, 2001; Wilson et al., 2005; • • • Djankov et al., 2006; • Baier and Bergstrand, 2007; • Jacks et al., 2008), International Borders: • (Anderson and Wincoop, 2003; Gorodnichenko and Tesar, 2009) For methodological issues: • (Egger, 2002; • Baldwin and Taglioni, 2006; . Silva and Tenreyro, 2006; • Helpman et al., 2008).#12Survey of Literature. While the gravity model has been increasingly used in international trade to estimate trade potential; very little work has been done to determine factors of PNG global trade potential. ▸ This project could be the first empirical initiative to determine and provide such analysis.#13Theoretical Justification. The gravity equation has long been an institutionalized topic of research in economics and there has been a great deal of studies on the gravity model itself. ▸ The properties of econometric estimations and methodologies make the gravity theory an interesting topic of research and inquiry. ▸ The developments of the gravity model can be discussed systematically in several developmental phases: • . ● 1885-1962: The Historical Roots of The Gravity Equation. • Linder (1961) and Samuelson (1948, 1949) 1962-1966: The Beginning of the Traditional Gravity Model • Pöyhönen (1963); Pulliainen (1963) and Linnemann (1966) 1966-2003: The Theoretical Foundations of the Gravity Model Bergstrand, (1990a) and Bergstrand, 1985, 1989) 2003-2017: The Revival of the Gravity Model. • Olivero and Yotov, (2012) and Anderson and Yotov, (2017)#14The Model. ▸ For estimation of the gravity model, we have followed Frankel (1997), Sharma and Chua (2000) and Batra (2006). ▸ With adjustment to suit our needs the model is "augmented" in the sense that several conditioning variables that may affect trade have been included. ▸ Thus the gravity model of trade in this study is: In(Xij) = ßo + ẞ₁ In GDP ijt + ẞ₂ In PCGDP ijt + ẞ3 In TRGDP ijt + ẞ4 In REMOTE¿¡ + ß5LANG + ẞlnPOP ijt + ẞ7RTA + εijt An alterative to the above will take care of the per capita GDP differential as a variable instead of per capita GDP. (Will be discussed in the final paper).#15The Model. The variables are explained as follow: In(Xij) denoted natural log of total trade it includes net exports and imports of country i to country j in the US $. Independent variables are: GDPijt the log of GDP of i country and j in US$. PCGDPijt is the log of the Per Capita GDP Differential between i country and j in US$. In TRGDPijt is the log of Trade as a percentage of GDP between country i and j REMOTEijt is the assessment of the remoteness between country i and j. LANGijt is common language between country i to country j (dummy variable). RTA is regional trading agreement (dummy variable) InPOPijt is the log of Population of country i and country j And "&" is the error term and "t" denotes time duration whereas' ẞs are the parameters. REMOTE = distij Σ GDPj GDPW a formula that measures a country's average weighted distance from its trading partners (Head, 2003), where weights are the partner countries' shares of world GDP (denoted by GDPW).#16Data, Methodology and Model Configuration. ▸ We will follow two step estimation strategies to explore PNG's global trade potential. In the first stage we have to estimate the initial model and the Per Capita GDP Differential using OLS estimation technique with cross section data for the year 2000 and 2019 covering 31 countries including PNG. ▸ The dependent variable is the value of total bilateral trade (export value plus import value will be in US dollar million) of country i (PNG) and country j (PNG's trading partner). ▸ The coefficients thus obtained in the first stage will then be used in the second stage to calculate the predicted bilateral trade of PNG with its 31 trading partners around the globe. These predicted trade values will then be analyzed and compared with the actual trade values to explore PNG's global trade potential. ▸ Econometric issues such Endogeneity, Multicollinearity, Heteroscadasticity will be taken care of as per econometrical process.#17Descriptive Statistics Regression Results Variable Variable Obs Mean Std. Dev. Min Max LNGDP Model 4 0.3475*** (0.0092) -0.2427*** LNGDP 1116 49.236 LNPCGDP 2.927 40.837 55.549 LNPCGDP 1071 9.731 1.430 3.884 11.542 (0.11) 0.1213** LNTRGDP 1116 4.266 LNTRGDP .6432 2.741 6.092 (0.0144) LNPOP 1116 32.784 2.343 27.091 37.448 -0.3998*** LNREMOTE 1116 -22.842 .8022 -25.304 -21.362 LNREMOTE (0.0136) LANG 1116 .4166 .4932 0 1 -0.2817*** LNPOP RTA 1116 .2222 .4159 0 1 RTA LANG (0.1048) -0.2205*** (0.0262) -0.1136 (0.0176) R² 0.83#18Estimates ▸ As per the theory, if the partner countries' GDP increases by 1%, it brings a significant positive impact on PNG's total trade which will increase by 0.34%. ▸ LNREMOTE is the assessment of the remoteness between partner countries; states that the further away a partner country is to PNG, trade will decrease by .39%. ▸ The coefficient value of the Per Capita GDP Differential is negative (-.2427). This reinforces other work in the body of literature that support the Linder hypothesis (Linder, 1961) that similar countries with similar Per Capita GDP seems to trade more in relative to dissimilar ones. The coefficient of RTA is depicted at -.2205 any new RTA will not be beneficial to PNG because it will reduce trade by .22%#19Trade Potential The gravity model was employed to predict future trade flows and capacity of PNG. ▸ The equation that formulates this simulation is as follows: TPi = Estimated Tradeij Actual Tradei ▸ The study has estimated the total trade potentials of PNG with 31 partner countries.#20Trade Potential Trade Exhausted Trade Potential Predicted Estimated to Predicted Estimated to Actual value of value of actual trade Actual value of In_TRADE_ij value of actual trade In_TRADE_ij In_TRADE_ij ratio In TRADE_ij ratio Fiji 14.062 15.697 1.116 Australia Singapore 21.206 20.082 .947 New Zealand 15.999 17.484 1.093 Vanuatu 13.127 14.688 1.119 19.474 19.352 .993 Sweden 14.668 15.282 1.042 China 19.526 17.960 .920 Malaysia 17.889 18.437 1.031 Japan 20.085 19.062 .949 Thailand 17.117 17.535 1.024 United Kingdom 18.806 18.322 .974 Bulgaria 13.549 14.165 1.045 Finland 12.521 15.225 1.216 Switzerland 16.915 16.062 .950 France 15.531 15.882 1.023 India 19.134 15.346 .802 Vietnam 15.996 16.09 1.006 Sri Lanka 13.975 12.67 .907 Indonesia 17.461 17.866 1.023 Hong Kong SAR, China 16.578 16.827 1.015 Russian Federation 15.524 16.663 1.073#21Conclusion ▸ Our first conclusion would be that since the coefficient of GDP is positive and highly significant as expected, this implies PNG tends to trade more with larger economies irrespective of distance. Since the coefficient for RTA is negative, we are of the view that PNG's involvement in her current RTA membership is creating a trade diversion. ▸ Given their growth trajectory and abundant resource potential, they provide a strong platform for greater economic engagement with Asia whom they have trade potential. Answering to our earlier question whether PNG can take advantage of their potential; we are of the view that this could be possible given that they have not fully exhausted their natural resources and most of the trade potential are with countries close by like the Asian countries, the Pacific and Europe.#22Policy Suggestions Based on the findings, this study recommends that: • • • PNG is to embark on the expansion of their mineral energy exports to new potential markets. . This export revenue should help them in developing and diversifying their industries especially Agriculture Apart from the NTMs the government recently raised the provision of higher tariff for domestic import- competing industry. • This may have an adverse effect on their exports if their trading partners responded negatively. PNG has trade potential with six (6) Asian countries within her reach. • The PNG government should strategically position herself in the northern segment of the South Pacific to bring these Asian countries closer in terms of trade and making them a gateway for the Pacific to these Asian economies. On the positive side, due to PNG's non reliance on tourism like most of the PICS and their positive trade balance, there is hope that they will achieve the revised economic growth from 3% to 3.7% as projected by IMF. Finally, PNG should push for economic transformation in the industries that have the potential to increase their international trade; this will have to be backed up with good governance, good environmental practices, international labor standards and a resilience policy that will sustain them during natural disasters.#23Thank You for Listening