A gravity model for world natural rubber trade

ABSTRACT The purpose of this empirical analysis is to investigate the determinants of world natural rubber trade flows based on gravity model among four largest exporting countries, name

UNIVERSITY OF ECONOMICS ERASMUS UNVERSITY ROTTERDAM

HO CHI MINH CITY INSTITUTE OF SOCIAL STUDIES

VIETNAM THE NETHERLANDS

VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

A GRAVITY MODEL FOR WORLD NATURAL RUBBER TRADE

BY

VO CONG DANH

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

ACKNOWLEDGEMENTS

First and foremost, I would love to sincerely express my thanks to my thesis supervisor Dr Pham Thi Bich Ngoc who provided me with invaluable academic guidance Her research experiences, particularly with the issue of international trade helped me from building thesis proposal to the final thesis report with patient and timely guidance

I would like to express my special thanks to Dr Tran Thi Thuy Hoa from Vietnam Rubber Association for her supports during writing this thesis

I would also like to extend my thanks to all Vietnam – The Netherlands professors, staffs for their knowledge, helps and encouragement In particular, I am very grateful to MA Nguyen Son Kien and MA Trinh Hoang Viet who are also VNP students, their enthusiastic support gives me invaluable advices

Finally, I would give the deepest thanks to my beloved parents who unconditionally support me in everything I do, including the completing of this dissertation

ABSTRACT

The purpose of this empirical analysis is to investigate the determinants of world natural rubber trade flows based on gravity model among four largest exporting countries, namely, Thailand, Indonesia, Malaysia, Vietnam and their fourteen major importing partners: Brazil, Canada, China, France, Germany, India, Indonesia, Italia, Japan, Korea, Malaysia, Poland, Spain, Turkey and the US in the period of 2000 to 2013

The thesis uses panel data in a gravity model with different fixed effects and GMM model with exogenous instrument variables to control for endogeneity problems causing by the correlation among independent variables and the error term as well as time-varying multiple price term The empirical results suggest that gravity model are reliably applied to a single industry, at least for the case of world natural rubber bilateral trade flows

Significant effects of economic size as well as and trade cost between trading countries with expected signs on world bilateral natural rubber trade reveals that both value and volume of bilateral natural rubber traded can be treated as alternative methods to explain the bilateral trade in gravity models even for disaggregated trade

The research findings also reveal that world’s natural rubber trade flows are positively affected by car production of importing countries when controlling for bilateral fixed effects and year dummies It means that almost natural rubber in ASEAN countries are exported to countries with developed rubber downstream industry

TABLE OF CONTENTS

ACKNOWLEDGEMENTS i

ABSTRACT ii

TABLE OF CONTENTS iii

LIST OF TABLES v

LIST OF FIGURES v

CHAPTER 1 INTRODUCTION 1

1.1 Problem statement 1

1.2 Research objectives 3

1.3 Research questions 4

1.4 Data and methodology 4

1.5 Thesis structure 5

CHAPTER 2 LITERATURE REVIEW 6

2.1 Trade theory 6

2.1.1 Absolute and Comparative advantage 6

2.1.2 Hecksher-Ohlin model 7

2.1.3 New trade theory 8

2.2 Gravity model 8

2.2.1 Traditional gravity equation 10

2.2.2 Anderson gravity equation 11

2.3 Empirical application of gravity model 12

2.3.1 Dependent Variable Specification 13

2.3.2 Traditional gravity variables for trade 14

2.4 Empirical research for natural rubber trade 19

2.5 Overview of world natural rubber industry 25

CHAPTER 3 DATA AND METHODOLOGY 29

3.1 Data Source 29

3.2 Model specification 31

3.3 Estimation strategy and correction method 32

3.3.1 Ordinary least square (OLS) 32

3.3.2 Fixed effect model (FEM) 33

3.3.3 Random effect model (REM) 34

3.3.4 Pooled OLS, Fixed effect or Random effect 34

3.3.5 Econometric problems 36

CHAPTER 4 EMPIRICAL RESULTS 38

4.1 Descriptive statistics 38

4.2 Empirical results 41

4.3 GMM model to control the potential endogeinety 48

CHAPTER 5 CONCLUSIONS 51

5.1 Main findings 51

5.2 Limitations and further studies 52

REFERENCE 54

APPENDIX 56

LIST OF TABLES

Table 2.1: Top tyre manufacturers worldwide in 2012 based on the tyre sale 21

Table 2.2: Some literature reviews about determinants of international trade using gravity model and natural rubber trade 24

Table 3.1: Data source of variables and their expected sign 32

Table 4.1: Bilateral natural rubber trade in 2000 39

Table 4.2: Bilateral natural rubber trade in 2013 40

Table 4.3: Correlation table of variables 41

Table 4.4: VIF results 44

Table 4.5: Estimation Results for world natural rubber trade value 45

Table 4.6: Estimation Results for world natural rubber trade volume 46

Table 4.7: Panel gravity equations in levels using various specifications 48

Table 4.8: Estimation results using GMM for controlling endogeneity 50

LIST OF FIGURES Figure 3.1: Diagram of the comparison progress between FE & RE models 36

Figure 4.1: World’s natural rubber production 2011 – 2013 (Unit: Tonnes) 26

Figure 4.2: Top natural rubber exporting country 2015 in term of value 27

Figure 4.3: World’s natural rubber export 2011 – 2015 (Unit: Tonnes) 28

CHAPTER 1 INTRODUCTION

1.1 Problem statement

The importance role of international trade in the world has been broadly studied in the many issues Many researchers have proved that increased participation in international market would motivate trade activities, which is an integral condition for further economic growth of any countries Joining global markets to connect with producers and buyers in many countries, trade provides an environmental for related parties to reduce the cost of production, attract foreign investment, enhance the value-added of their products and provide countries opportunity to move up global value chain Which is the recent strategic orientation followed by developing and emerging countries in Asia and ASEAN countries A fundamental factor behind their rapid economic growth has been their ability to strengthen the competitive productive and export abilities, first in traditional agricultural industry and then in labour-intensive manufactures

The growing role of globalization today makes international trade become one of the most issues need to be discovered with multi-million negotiations take place every day However, a number of areas of international trade are still not thoroughly studied and current traditional theories of trade also need to be further employed in empirical application

Although many trade theories primarily try to question why nations trade with one another? However, a quantitative question of how large and the destination of trade still remains as substantial field for further studies In recent years, gravity model has appeared as the most fashion and successful analytical instrument to quantify international trade flows, particularly thanks to the high

explanatory ability and available data for easily collecting regarding to international trade statistics of goods

According to Prehn and Brümmer (2011) a huge number of papers using gravity trade models to investigate the disaggregated data trade flows, however, the applications to a single commodity industry are still room for further study Particularly, investigating the determinants of bilateral trade flows for the specific industry in developing countries is a practical empirical task

In fact, the analysis of bilateral trade flows is significantly essential for the natural rubber industry This is true for rubber importing nations, which are natural rubber main end-users, and rubber producing countries, which are more and more depending on natural rubber trade as main source of national income and employment generation Natural rubber is one of the most essential natural resource in ASEAN area which relates to foreign exchange earnings, unemployment reduction, and last but not least, material input to the industrial production in both home and foreign markets

By 2013, rubber production of four largest producing countries, namely, Thailand, Indonesia, Malaysia, Vietnam, respectively, has a share of around 82.2 percent of world production, according to the Association of Natural Rubber Producing Countries (ANRPC) Base on the data collected from UN Comtrade, world natural rubber import value have grown dramatically in recent years, rising from about 3.8 USD billion in 2000 to almost 25.2 USD billion in 2013, in which the contribution of 4 largest producing countries account for 78 percent to 84 percent, with an average annual growth rate of almost 15.6 percent (CAGR) However, the downsizing of the world’s trade of natural rubber in term of US value from 9 percent for 2000 – 2010 reduce to -28 percent for 2011 – 2014, and expected would continue decline in the coming years, which is attributed to the consequence of uncontrolled rubber plantations in the period of 2005 – 2011 by Thailand, Indonesia, Malaysia, Vietnam and even China With the high proportion of natural

rubber production joining international market, the study of natural rubber trade is importance for any policy related to rubber industry In this study a gravity model is developed to discover the possibility of using gravity model to explore the trade flows of world natural rubber and to test whether world natural rubber trade depend on the development level of downstream industries.

Although the natural rubber has an important role as a critical material input for the production of elastomers which are essential in automotive and general rubber goods industry since they can be almost distorted and still return to their original shape Due to this unique property, natural rubber is used by variety of industries to produce tires, gloves, condoms, mattress, equipment for general physical exercise, automobile spare parts such as mounts, springs, absorbers, and dampers, etc The empirical literature analyzing natural rubber international trade

is still rather limited

As few number of empirical analyses available in this area, existing researches just focus on investigating the determinants of natural rubber trade for a single country as Yusof (1988), Kannan (2013), Chawananon (2014) Therefore, we have mainly concentrated on applying the gravity model to explore the bilateral trade at disaggregated level between four largest natural rubber exporting countries including, Thailand, Indonesia, Malaysia and Vietnam which accounting for 82.2 percent of world production, with their fourteen major natural rubber importing countries which accounting for over 90 percent of world import, namely: Brazil, Canada, China, France, Germany, India, Italia, Japan, Korea, Malaysia, Poland, Spain, Turkey and the US in the period of 2000 to 2013

1.2 Research objectives

From those important points stated above, the main objectives of the study are: Investigating whether world natural rubber bilateral trade depend on the development level of rubber downstream industries

(2) Do factors such as Industrial Production Index (IPI) and car production of natural rubber importing countries have significantly positive impacts on bilateral natural rubber trade?

1.4 Data and methodology

This study uses the annually bilateral natural rubber trade data collected panel data of four exporting countries and their fourteen major trading partners on United Nations Comtrade Database (UN Comtrade) from 2000 to 2013 The data of GDP and Population will be collected through World Bank Data of bilateral geographic distance and trade cost are taken from The United Nations Economic and Social Commission for Asia and the Pacific (ESCAP-World bank) database The data of country industrial production index (IPI) will be gathered from The International Monetary Fund (IMF), while the car productions are available on The International Organization of Motor Vehicle Manufacturers (OICA) website After acquiring the strongly balanced panel data, the Ordinary Least Squares (OLS), Fixed effects (FE) and Random effects (RE) model are employed to analyze the relationship between natural rubber trade flows and its explanatory variables The outcomes of different Fixed effects models are considered as main results

1.5 Thesis structure

The thesis is arranged for five chapters as follows:

The introduction chapter is followed by the literature review, in which I deployed the traditional trade theories and literature review on gravity model for trade, particularly concentrate on theoretical review of trade and the empirical study for natural rubber industry related to trade issues, eventually i will details the overview of world natural rubber industry

The third chapter represents the data and methodology using to discover the bilateral natural rubber trade and data used in this thesis

The chapter four details including the descriptive statistics of some interested variables, and the outcomes collected based on the methods discussed in chapter three

The last chapter is for conclusion and some policy recommendations for orientating the development strategy of natural rubber exporting countries

CHAPTER 2 LITERATURE REVIEW

2.1 Trade theory

What are the origin of international trade? Do trade create benefit to all trading parties? How much and where of those goods are traded? It is necessary to review the fundamental trade theories to answer distinctly these first two questions The coming part will introduce a brief summary ofsome trade theories supporting reasons behind trade activities Finally, the last question above that still not be explained by traditional theories of trade will be explained by gravity model

2.1.1 Absolute and Comparative advantage

Adam Smith was not only known as one of the most famous English economist but also as the father of absolute advantage theory which mentions that countries trade with others due to their different productivity In details, his well known book published in 1776 “The Wealth of Nation" noticed that nations should produce and export solely goods that they can produce cheaper than other countries

or have absolute advantage, then exchange with others, all related parties would benefit in international trade even though the benefit from trade would not be shared equally

At that time, his argument was reasonable only for countries which have absolute advantage, it left a question of why countries still got advantage from international trade, even though they did not have absolute advantage

The other theory explained international trade based on principle of comparative advantage was originally pointed out by David Ricardo another English political economist in his book “On the Principles of Political Economy published in 1819” helped to answer the question left by Adam Smith, which mentioned that

countries trade with others due to their difference in country’s opportunity cost In fact, the opportunity for producing the particular good and service at one country compared with others is the fundamental idea behind the comparative advantage It

is no doubt that international trade is fundamentally explained via comparative advantage However the comparative advantage based model was still imperfect in many situations to explain international trade

2.1.2 Hecksher-Ohlin model

Fulfilling the gaps of Ricardian model, the new theory known as the factor endowment theory or Hecksher-Ohlin model (HO) introduced by Eli Hecksher and Bertil Ohlin had extended the classical theory which seems to be old-fashioned According to Husted and Melvin (2001) the HO indicates that not all countries gain from trade, in fact the benefit from trade activities belong to those who are the owners of abundant resources, otherwise the owners of scarce factors lose

There are two dimensions that distinguish the difference between the HO model and the Ricardian model Firstly, compared to the Ricardian model, HO model adopts a more realistic framework by allowing for a second factor of production in the form of capital Secondly, HO also emphasizes that comparative advantage attributes trade activity due to the difference in endowments of factors of production not on the difference in the production technologies between countries

The basic core of HO model suggesting that traded commodities are the combination of factors including land, labor and capital Hence, the exchange of commodities internationally means that countries export products that they have abundant factors and import products based on the scarce of factors

The most important implication of the HO model is that the option to sell factor services externally transforms a local market into a global market As a result, the demand for inputs becomes easier to change and more similar over countries

2.1.3 New trade theory

The new trade theory was originally developed by Lancaster, Helpman, Markusen, and many others in the in the 1980s The motivation of new trade theory

is to explain the case of trade in developed economies in which trade takes place even with country has similar factor of endowments and within intra industrial trade with others The new trade theory rejects some assumptions and conclusions

of neoclassical theories, it considers the principle of comparative advantage as the fundamental basis of the existence of international trade In fact, new trade theory attributes international trade to the economic of scale, imperfect competition and product differentiation, while classical theory attribute international trade to the constant return to scale, perfect competition and homogeneous goods

To sum up, new trade theory indicates that each country can produce goods with larger scale as long as they have higher productivity and lower costs for producing Then it can exchange goods with others through trade Trade happens even when resources and technology between countries are the same (see also Markusen et al, 1995; Krugman and Maurice, 2005) For example, today Malaysia is known as main natural rubber producing country, however it continuously depends

on importing that raw material from Thailand and Vietnam

2.2 Gravity model

The gravity model, which associates trade flows to economic size of country, bilateral geographical distance as well as determinants of trade, is one of the most successful models and broadly applied not only in trade research such as Anderson and Van Wincoop (2003), Natale et al (2015) but also for non-trade application such as the trends of regionalization, migration flows, cross-border equity flows According to Deardorff (1998) the main components of the gravity model (economic mass and geographical distance) are well interpreted by factor endowment theory

or Heckscher-Ohlin assumption

The classical notion of gravity model originally initiated by Nobel laureate Jan Tinbergen (1963) based on the Newton's law of gravity in which every two objects

constant f is an empirically determined value:

Applying to international trade, gravity model considers the trade flows as the "gravity attraction" between two trading partners and has the same relationship

gross domestic product (GDP), population and the distance between them However, there are variety measurements which can express the size of countries Normally, the GDP of a country is usually used to measure the economic size of any trading partners However, we can also turn to GDP per capita, GNP, GNP per capita, population and even the total import-export demand of a country for the specific product in doing sector analyzing

The theory suggested by Anderson is applied to develop theoretical model of this thesis, in which he implied that the model is fundamentally the expenditure

Let us denote the economic size of exporting country i and importing country

trade activities are associated solely to geographical distance between pairs trading countries, thegravitational constant for the "multilateral resistance term" (MRT)is

an integral part of gravity model, is deployed as below:

then the equation(2.1) gets the form:

In following sections we express the way to convert the theoretical model into the stochastic processto quantify by econometric tools

2.2.1 Traditional gravity equation

From the theoretical model in equation (2.3), we can rewrite the gravity model as follow

Where Tij denotes the trade flows between the exporting country i and

assumption leads to:

To transform the multiplicative form of gravity model to standard estimation model in equation (2.5), we have to transform the model into logarithm form, once

we obtain a linear relationship which permits to interpret coefficients as elasticity

as below:

The coefficient can be explained as follows: if the economic mass of exporting

paribus Vice versa, if the distance between countries i and j increases by one per

2.2.2 Anderson gravity equation

Based on the theory concept introduced by Anderson discussed above, the purpose of this part is to quantify the stochastic version of the equation (2.4) which could be rewritten as follow:

(MRT) According to Beverelli and Lanz (2015) there are three ways to solve the MRT: “(1) Anderson and Van Wincoop (2003) use an iterative method to solve MRT

as function of observables; (2) Proxy MRT using remoteness REM (trade/GDP weighted average distances from the rest of the world); (3) Fixed effects”

Anderson and Van Wincoop proceed all өi and өj (i, j = 1…N countries) as endogenous by using a custom nonlinear least squares program, they also suggest

an alternative method for accounting for MRT using countries specific fixed

economic center and other things related to costs hindering country international trade Stochastic version of gravity model has the form:

Estimating the equation (2.7), we again transform it into the logarithm form:

Traditionally, cross-sectional data are widely applied to analyze gravity model, the drawback of cross-sectional is that it does not take the difference of unobserved fixed effects of time, country, country pairs fixed effects, etc, into the consideration The pooled OLS method to estimate cross-sectional data is appropriate unless these unobserved fixed effects are not correlated with other regressors Otherwise, we need to find other appropriate methods

Considering the unobserved fixed effects, a number of current literatures have tried to estimate the equation by using panel data model which permits

considering more potential kinds of unobserved fixed effects Fixed effects control for all unobserved characteristics that affect its propensity to trade (import, export)

We now include exporter, importer, country pairs as well as both country pairs and time dummy fixed effects into the estimation which leads to:

Tijt = β0TCijtβ1Yitβ2Yjtβ3π̅iχ̅j̅ij̅ijtℰijt (2.9)

In which t stands for the time dummy fixed effects The logarithmic transformed model of panel data estimation has the form:

In this study, the results collected from different fixed effects models as exporter, importer, country pairs, a well as both country pairs and time dummy fixed effects including others factor affecting bilateral natural rubber trade are considered as main results

2.3 Empirical application of gravity model

There are many researchers applied gravity model to quantify the trade flows

in country level, it is easy to come across variety versions of gravity equation However, there are some common features to identify that model Firstly, gravity model is widely applied to explain trade flows between bilateral trading countries, the trade flows which used as dependent variable in gravity equation is normally measured by either trade value or trade volume Secondly, economics size of country and their trading partners are usually measured by GDP, GDP per capita, GNP, GNP per capita, population, and some variables can be treated as proxy for the attraction of “economics mass” Third, distance is another prominent factor in gravity model which always plays as proxy for all trade costs that affecting trade and it usually uses the geographical distance between the countries’ economic centers as measurement

As emphasized by Wang Wei and Liu (2010) there are many controversies by researchers about the optimal proxy variables to contain in the right hand side of

gravity model In this dissertation we will follow the primary model by Anderson (1979), Anderson and Wincoop (2003), Baier and Bergstrand (2007) as well as adding factors that affect natural rubber trade and strive to examine the possibility

of using different proxy variables in gravity model analyses It is discussed further in next section

2.3.1 Dependent Variable Specification

There are two alternative methods to measure the trade flows of goods as the dependent variable are value and volume of goods traded of which Bergstrand (1985) uses the currency value of goods exported from exporting country i to others

as the dependent variable, if the prices of that good remains unchanged over the period, the trade value is simply the quantity of exported goods multiplied by some constant For instance, in 2011 saw the 50 percent increase of world natural rubber price compared with the previous year, a model using the currency value of goods exported as the dependent variable would consider this as a 50 percent increase of world rubber trade flows, however the impact of other determining variables on the trade value is unlikely to have impacted as same proportion In fact, the prices of natural rubber and trading flows would clearly move in opposite instead of the same directions The outcomes collected become ambiguous when adding price variable into the equation Prentice et al (1998) use volume of trade measured in metric tons to analyze the export of Canadian pork industry in their analyses, the results show that gravity model is applicable to explain the Canadian pork industry

in term of trade volume However, Vido and Prentice (2003) argue that both value and quantity of goods traded could be treated as alternative measure for trade flows Nevertheless, the quantitative data is unlikely affected by transport costs, moreover, when the prices of exported goods increase, higher freight rates are likely

to impose by transportation agencies, and vice-versa

Aggregate trading data would take all commodities into consideration, from high valued items, such as luxury cars, and low valued raw materials, as natural rubber

A common unit of measure for all goods traded is convenient for analysis and comparison However, the each commodity has its own sensitivity to transportation costs, it is the problem arising when we use aggregate value For example, a unit container of natural rubber (20.16 MT) has about the same value as a truckload of a unit container of two or three ordinary cars, but the absolute costs of transport are absolutely different

In this work, we try to compare the outcomes of the empirical analysis concerning to the performance of the quantity (kg) and values (USD) of goods traded as alternative proxy variables for bilateral world natural rubber trade

2.3.2 Traditional gravity variables for trade

 Factors that supporting trade

There are huge previous empirical studies on this topic Rahman (2003) uses import, export and sum of exports and imports, three alternative equations to estimate the determinants of Bangladesh’s trade flows with its major trading countries The results show that Bangladesh’s trade is primarily affected by the country’s economy size (GDP), GNP per capita, and economy openness of trading countries In this thesis we only use export volume to estimate world natural rubber trade as we assume that the four largest rubber exporting countries no need to import rubber to serve their domestic demand due to the available abundant resources (although, recently Malaysia has increasingly imported natural rubber from Vietnam for further process and re-export) Thai (2006) indicates that the bilateral trade flows tween Vietnam and twenty-three European (23EU) countries are positively determined by economic size (GDP) as well as market size (population) which is suggested that trade between Vietnam and 23EU countries increased 0.29 percent when GDP of them increased by 1 percent While, an increase

in population by 1 percent leads to 7.9 percent increase in trade between them, it indicates that the more population are the more market ability to absorb import is

Khiyavi et al (2013) use gravity model approach, in a sample of 14 exporting countries from 1991 to 2009 to investigate the determinants of agricultural commodities international trade in developing countries, the results show the economic size of both the exporting and importing countries is positively affect trade in agricultural products Khan et al (2013) apply gravity model to explore the Pakistan’s bilateral trade flows, these outcomes indicate that Pakistan’s bilateral trade flows are well explained by gravity model due to the high value of R-square and adjusted R-square, moreover, GDP and GDP per capita showed a positive effect

to trade volume, however, distance and the cultural similarities is negative impact to the trade flows

Natale et al (2015) analyzes of the determinants of international seafood trade using gravity model in the effort of comparing with meat industry trade The results do show seafood industry trade is determined positively by their

primary production of exporting countries

 Factors that hindering trade

The other prominent variables for any gravity model application are trade costs Within the comprehensive reviews on the application of gravity model on trade, it is not strange to get some common explanatory variables that proxy for trade costs Persson (2013) evaluated the effects of time to export on the volume of goods traded between EU countries, Dennis and Shepherd (2011) in the analysis of the relationship between trade facilitations and trade diversification in the sample

of 118 countries found that customs costs play as the most important role for improving trade diversification On the other hand, Anderson and Van Wincoop (2003) use common in border as the variables that proxy for trade costs on trade, they point out that common border reduces trade between the US and Canada by 44

percent…Other studies have been further extended gravity model by estimating variety proxy variables that may be negatively affect trade such as infrastructure, landlocked or island effects, as well as historical ties, export tax, cultural unfamiliarity The scope of this research is just deal with the trade flows of 4x14 nations setting, so that we assume infrastructure, landlocked or island effects, as well as historical ties, cultural, unfamiliarity and etc have no effects on world natural rubber trade

Researchers who advocate geographic distance between countries is a good proxy for variables hindering trade as they argue that direct measures of distance costs are often unavailable One of these important empirical findings in international trade done by Leamer and Levinsohn (1995) indicated that geographical distance and bilateral trade flows absolutely move on opposite direction Using gravity model, Khan et al (2013) indicated that Pakistan’s bilateral trade is inhibited by distance and the cultural similarity with its trading partners The study done by Natale et al (2015) about the determinants of seafood trade using the trade data of 197 countries and 120 seafood categories revealed that seafood trade is inhibited by the geographical distance between the trading partners and by labour costs for further processing, the higher the labour cost for processing the lower demand for seafood Otherwise, the study also reveals that distance is not an impedance factor for trade in an industrial use and feed industry In addition, the result of former research on dividing trade into three categories: agriculture, manufacturing and service show that higher distance effects for manufacturers than for agricultural products or other raw materials Martínez-Zarzoso et al (2004) investigated trade flows by categorizing export to different industries based on their own sensitivity to distance costs Applying the gravity model on trade they recognized that geographical distance had significantly negative impact on the footwear and furniture trade flows among fifteen EU members and

MERCOSUR countries plus Chile including Argentina, Brazil, Paraguay, Uruguay, Venezuela and Chile.

Yet, the information containing in the coefficients of distance obtained from gravity model is still ambiguous However, the negative sign of the distance coefficient are explained as meaning that country is likely to trade with others that are located nearby could be confusing, in fact, distance coefficients may vary depending on the goods to be traded as well as the differences among bilateral trading partners In recent year, many factors such as information costs, tastes and preferences, and unfamiliarity have been taken into account as the factors that hinder trade by many researchers other than the impacts of geographical distance Filippini and Molini (2003) expressed that “distance is much more than geography: it is history, culture, language, social relations and many other things” Using the gravity model, Buch et al (2004) divided exporting countries to different groups and suggested that the developing countries tend to trade with their neighboring partners, and of course the propensity to trade with far away countries reduce overtime Blum and Goldfarb (2006) introduced a new explication for the effects of distance in gravity model arguing that the effects have no meaning for internet trade in the fact that transportation costs, and other impedance factors associated with distance are trivial Huang (2007) mentioned that unfamiliarity can be explained part of the negative relationship between geographical distance and bilateral trade flows, he showed that when taking country fixed effects into consideration the magnitude of distance effects reduced by 13.55 percent for developed countries and increased by 29.7 percent for developing countries over the period of 1980 to 1999, suggesting that trade in developing countries is more sensitive to distance than in developed countries

However, on the opposite point of view, there are many authors also mention that there is little evidence supporting the using of distance as a proxy for trade costs A number of previous empirical studies have proved that geographical

distance have no impacts on the value of goods exported and of course have no effects to international trade activity Most prominent among them are Geraci and Prewo (1977), they revealed many arguments that make distance are not very helpful in forecasting trade flows Firstly, trade costs are determined by a lot of factors besides distance, such as tariffs, quantities, bulk as well as the property of goods being traded, and last but not least, the mean of transport In addition, the use

of geographical distance supposes that trade activities are not influenced by factors other than geographical distance, it seems to be irrational in reality In addition to Vido and Prentice (2003) stated distance can’t be representative for countries sharing long common border line with goods moving through multiple entry points Second, allowing the fluctuation in the cost of different means of transport may cause some unexpected problems For example, the costs of transport services will

be reduced and customer demand for goods traded will increase when the technologies for transportations are improved, the lower the transportation costs the lower the prices of goods

A lot of researchers agreed that the effect of distance on trade remained unchanged considerably over time, and this could be considered as evidence against the negative impact of distance costs on trade, they also suggested that the explanation of distance coefficients is confusing Therefore, distance costs can not be interpreted through distance coefficients collected even from panel data analysis In the particular case of the reduction in distance costs and the increase in bilateral trade, proportionally, the impacts of distance could elicit only throughout the constant term of empirical equations

However, it does not indicate that distance coefficients have no correlation with bilateral economic linkage The reducing distance costs do have caused a significant increase in international activities of all aspects Hence, the often proclaimed ‘death of distance’ has not occurred, and distance still plays as an integral part of international trade activities To what extent, the suitable

explanation of constant distance coefficients is that international trades between countries that are located far away or close from each other have expanded at approximate proportions According to Márquez-Ramos (2007) the magnitude of the impact of transport costs on trade fluctuates from 8 percent to 13 percent of the export volumes depending on the place that trade happened.

In spite of their importance, few studies have concentrated on analyzing the impacts of trade costs on trade, instead a number of papers consider only proxies for trade costs in their empirical researches The researches of the relationship between trade costs and bilateral trade have primarily been done at an aggregate data level, it is still room for disaggregate sector level application For example, many researchers were used to using geographical distance as a proxy for bilateral trade costs, however, there are others proxies for transport costs that were applied are: contiguity, island - landlocked country, common language…

One of the purposes of this thesis is to analyzing the impacts of trade costs at disaggregated sector level for world natural rubber trade

2.4 Empirical research for natural rubber trade

In general, rubber demand originated from the consumption of rubber by end products, based on the material input for producing rubber products it is commonly divided into two main groups One group made from concentrate latex and other made from block rubber (TSR) and ribber smoke sheet (RSS) To be more details, the products made from concentrate latex or dripped product such as gloves, condoms, mattress and threats…which is also called the general rubber products whose demand is again determined by many other factors such as income, prices and consumer preference etc However, the most critical determinants of rubber demand are depended on the tyre and automobile spare part industries that made from TSR and RSS

Figure 2.1: Simple value chain of rubber products

Source: Draw by author

In fact, tyre have always been the most important determinant of rubber demand Despite the increase share in terms of rubber consumption in the rapid expansion of the general rubber products sector lately, tyre still account for more than 50 percent of all elastomer (natural and synthetic rubber) produced in the world today Barlow, Jayasuriya and Tan (2014) In term of natural rubber industry, about more than 70 percent of them are consumed by the tyre industry, in which top 10 tyre groups accounted for nearly 65 percent of the world’s tyre sales in 2012 Tables 2.1 at hand is a portrayal representation of Top 15 tyre manufacturers worldwide in 2012 based on the tyre sales

Shoe soles, tubes, belts…

Technical rubber products: gaskets, seals…

Tires, inner tire…

Mattress, Threat, inflatable ball,

Concentrate latex

Rubber block, Rubber Sheet

Field latex

Table 2.1: Top tyre manufacturers worldwide in 2012 based on the tyre sale World ranking Name of manufacturers Country

Source: European Rubber Journal, September/October 2013 Traditionally, tyre makers located in North America and Western Europe have been the most important users of natural rubber for making tyre serving their automobile industries As there is a direct relationship between consumption of tyre and demand for automobile in these two continents at one time, to what extends, the demand for rubber depends directly on the development of the automobile

industries and economic condition in the west When there was general improvement in the economic growth in North America and Western Europe which usually led to greater demand for cars, both demand and prices of rubber could be expected to go up However, when the world was hit by recession, rubber farmers, both estates and smallholders could expect difficult time ahead, compared to North America and Western Europe, Eastern European countries have much less influence

on the rubber market One major factor that accounts for the lack of influence of these countries on natural rubber demand is their bias against natural rubber Most industries in Eastern Europe prefer to use synthetic rubber rather than natural rubber Such bias perhaps stems from the fact that synthetic rubber could be produced locally in these countries but natural rubber must be imported solely from ASEAN countries

In 1990s, the Asia-Oceania countries have emerged as important tyre producers as well Among the major producers of tyre in this region Japan, China and Korea production have been expanding rapidly Such rapid expansion in their tyre industries is a result of the economic growth of these three countries which leads to increased demand for automobiles and commercial vehicles which in turn generates demand for tyre By 2013, China became the world largest tyre production country follows by the US, Japan, Korea, Thailand, Germany, respectively…

their own spearhead industries based on the abundant of available natural rubber Historically, Thailand and Indonesia have been themselves developing and becoming the largest producer of rubber automobiles parts in South East Asia, as the two largest natural rubber producing countries Thailand and Indonesia thus do not rely on imports However, in recent year, Malaysia has been continually relying

on importing natural rubber for serving their dipped rubber goods industry and today Malaysia is known as the world's leading medical gloves (examination and

surgical gloves) supplier, accounting for more than 50 percent of global demand, it

is also the world's largest supplier of catheters and condoms and the second leading exporter of latex threads (in value terms) With the development of rubber downstream industry, it is not surprise that Malaysia either main natural rubber exporting country or natural rubber main importing country In addition, Thailand, Indonesia and Malaysia also manufacture a wide range of industrial rubber products such as tyres, hoses, beltings, seals, wires and cables for the global market

When it comes to the industrial production index (IPI), it is a statistical measurement tools which measures the progression of industrial production According to Amarasinghe (2016) the IPI include many kinds of sectors in which Food, beverage and tobacco sector account for 46.9 percent, Textile, Apparel, Footwear and Leather goods (22.7 percent), Chemicals, rubber, plastics and petroleum (14.2 percent), Fabricated metal products (7.7 percent), Non-metallic mineral products (5.1 percent), and other Products (3.4 percent) Amarasinghe (2016) also reveals that industrial production index has the statistically positive impact on the beverage, food and tobacco industry in Colombo Stock Exchange Sri Lanka In fact, the demand for many commodities considered as raw material for production as rubber and palm oil are also positively affected by how good of the industrial production of a country is?, an increase in the IPI would stimulate the demand for natural rubber and vice versa stated by Yusof (1988)

In this dissertation we will analyze the determinants of natural rubber trade

by adding factors such as car production and the industrial index of importing countries as proxies for the demand of raw natural rubber, which is discussed further in the next section

Table 2.2: Some literature reviews about determinants of international trade

using gravity model and natural rubber trade

1988 Yusof 1960 -

1981

2SLS Export demand for Malaysian rubber is

determined positively by world industrial production index

2003 Rahman 1972 -

1999

Gravity model, panel data

Bangladesh’s trade is primarily affected

by the country’s GDP and GDP per capita

2006 Thai, T D 1993 -

2004

Gravity model, Fixed effects

Trade flows are positively determined

by GDP as well as population Distance has no effect on trade

2010 Hassan et al 1998 Gravity model,

OLS India natural rubber export would

positively affected by world population

Gravity model, Meat exports are affected positively by

GDP per capita Seafood trade is inhibited by the geographical distance

Source: Author

2.5 Overview of world natural rubber industry

Since the post-war period until 2013, the world production of natural rubber had increased more than 6 times, from close to 2 million tonnes in 1955, the world production of rubber increased to 12.3 million tonnes in 2013 according to the International Rubber Study Group (IRSG) In terms of geographical distribution, majority of rubber produced comes from South-East Asia particularly in Thailand, Indonesia, Malaysia, and Vietnam In 2013 these four countries produced more than

74 percent of the total rubber produced in the world In 2013, China, India, and Sri Lanka produced 865,000 tonnes; 796,000 tonnes and 130,400 tonnes of rubber respectively ANRPC (Jan 2016) However, India and China are net importers of rubber since the total consumption of rubber in these two countries exceed that of their total production Traditionally, Malaysia has been the world largest natural rubber producing country and represented for 39 percent of world share in 1960 However after a couple decades, by 1980, the contribution of Malaysia natural rubber in the world market increased to 40.1 percent prior to witness an unexpected decline thereafter In 1991, Malaysia could no longer remain as world’s number one position, instead, both Thailand and Indonesia eventually overtook Malaysia to become the two largest rubber producers in the world Today, Thailand still remains as the largest producer which produce 4.17 million tonnes of natural rubber in 2013 accounting for 34 percent of the world's natural rubber production (Fig 2.2)

Of late, there appears to be revived interest in rubber among some other South-East Asian countries such as the Philippines, Vietnam and Cambodia Among these countries, development in the Philippines appeared most promising, from about 69,900 tonnes in 1980, Philippines' rubber production went up to 111,200 tonnes in 2013 Vietnam too showed remarkable progress, its production at 41,100 tonnes in 1980 surged to 946,900 tonnes in 2013 In the past few years, Vietnam has

shown keen interest in the revival of its rubber industry and was known to have solicited technical aid from Malaysia with improved technological progress and better management expertise adopted in its rubber industry and newer clones of rubber which explain why today Vietnam’s natural rubber average yield is highest compared to Thailand, Indonesia and Malaysia (1.732 tonnes per hectare in 2013) Apart from South-East Asia countries, African countries are another source of rubber supply though on a much smaller scale among the major rubber producing countries in Africa include Liberia, Nigeria and Cote d'Ivoire Latin American countries where rubber originated just has little progress in rubber production

Figure 2.2: World’s natural rubber production 2011 – 2013 (Unit: Tons)

Source: Compiled by author from IRSG (2015) and ANRPC (Jan 2016)

About 70 percent of natural rubber production ended in international market The bulk of this rubber was largely consumed by China and Western countries such

as the United States (US) and EU countries Traditionally, the United States and EU countries had been the most important importers and consumers of natural rubber Since 2002, China has overtaken the US and EU countries to be the largest natural

rubber importer, by 2014 China consumed 39.1 percent of world natural rubber Currently, the others important importing counties in Asia are Japan, Korea and Malaysia The dominant position of the US, EU countries and also Japan in the international natural rubber market is attributed to the automobile and tyre industies which are the biggest users of natural rubber

Global sales of natural rubber exports by country in 2015 was US$ 14.2 billion That amount represents an average of -22.8 percent drop in value compared

to 2014 when natural rubber trades were valued at $18.4 billion Among continents, Asian countries accounted for about $12 billion or 86 percent of international natural rubber trade African exporters supplied 7.3 percent followed by European with 4.7 percent

Figure 2.3 displays the share of main natural rubber exporting countries in the world market in 2015 in which Thailand accounts for 35.8 percent, Indonesia shared 31.5 percent, Vietnam 7.5 percent, Malaysia 7.4 percent and rest of the world (ROW) 17.8 percent

Figure 2.3: Top natural rubber exporting country 2015 in term of value

Source: Compiled by author from http://www.trademap.org/

From 1991 to 2014, Thailand was the world largest natural rubber exporting country followed by Indonesia, Malaysia and Vietnam, respectively However, by the end of 2014 until now, Vietnam is officially to be the third largest natural rubber exporter after Thailand, Indonesia and just slightly ahead of Malaysia Figure 2.4 displays export value of four largest natural rubber exporting countries in 2015

Figure 2.4: World’s natural rubber export 2011 – 2015 (Unit: Tons)

Source: Compiled by author from IRSG (2015) and ANRPC (Jan 2016)

CHAPTER 3 DATA AND METHODOLOGY

3.1 Data Source

The natural rubber trade data of four largest producing countries, namely, Vietnam, Thailand, Malaysia, and Indonesia with their fourteen major trading partners namely: Brazil, Canada, China, France, Germany, India, Italia, Japan, Korea, Malaysia, Poland, Spain, Turkey and the US in yearly figures of 2000 – 2013 are extracted from United Nations Comtrade Database (UN Comtrade) UN Comtrade was established in 1960, it provided trade data information and database to many agencies with the trade data statistics reported annually by worldwide countries The data used in this thesis contains about 784 observations for all data set Natural rubber is classified according to the Harmonises System classification at four digits

of details in which it falls in code HS 4001

The product of GDP at market prices (current US$) is obtained from the World Bank, there are variety ways to calculate GDP including in current prices, constant prices or purchasing power parity It is widely controversial which measure is the best appropriation for trade researches, in this thesis i will use the GDP at market price, populationare also taken from the World Bank (WB)

The data of distance and trade costs are taken from ESCAP-World Bank In which, distance is the geographical distance between trading countries which plays

as an integral part of any gravity model Distance is measured by geographical kilometres between capital cities Byers (1997) ESCAP-World Bank initially introduced the bilateral trade cost database in 2010 in an effort of providing the cost of bilateral trading between countries worldwide for research purposes

The bilateral measure of featured specific trade costs in this database is a comprehensive all-inclusive measure based on micro-theory and calculated using