Short and medium run structural change in a gravity model of international trade

In this paper I use a gravity model of international trade patterns to determine how changes in the institutions, proxied with an economic freedom index, affect changes in trade patterns between the US and 130 trading partners over varying time horizons using a “dynamic” panel gravity model by considering changes in trade over five time horizons from one to five years. In this paper I use a variety of different panel methods including fixed, random, and dynamic panels. In addition, I look at how changes in institutional integrity asymmetrically impact imports and exports, unlike in standard models which only consider the total volume of trade (exports plus imports). While institutional strength has been shown to positively impact trade flows, this result is only when modeling concurrent levels of trade, not in changes in trade flows over different time horizons. Additionally, I take advantage of five sub-freedom indices-- size of government, legal systems and property rights, sound money, trade freedom, and regulation -- to investigate which "type" of institutions have the largest impact on trade flows.  My preliminary results suggest that institutions, as proxied by economic freedom, become increasingly important over time suggesting that while institutional reforms may not provide an immediate improvement in economic performance, they do provide real benefits over longer time horizons. Moreover, I demonstrate that there are trade asymmetries with respect to imports, exports, and the total volume of trade. Finally, I find that improvements in business regulation have the largest impact on trade flows between the US and its trading partners. This research provides a blueprint for an economy to follow by identifying which modifications to economic freedom will have the largest impact on trade flows and thus on overall economic welfare.