Determinants and Potentials of Foreign Trade in Ethiopia: A Gravity Model Analysis

In this study, attempts are made to provide a theoretical justification for using the gravity model to analyze bilateral trade flows. The augmented gravity model was adopted to analyse Ethiopia's trade with its main trading partners using the panel data estimation technique. Estimations of the gravity model for export, import and total trade (sum of exports and imports) are carried on. The estimated results show that Ethiopia's export, import and total trade are positively determined by the size of the economies, per capita GDP differential and openness of the trading countries' economies. Specifically, the major determinants of Ethiopia’s exports are: size of the economies(GDP's of Ethiopia and that of partner), partner countries’ openness of economies, economic similarity and per capita GDP differential of the countries. All these factors affected Ethiopia's export positively except similarity indicator. The exchange rate, on the other hand, has no effect on Ethiopia's export trade. Ethiopia's imports are also determined by GDP's (of Ethiopia and the partner country), per capita income differentials and openness of the countries involved in trade. Transportation cost is found to be a significant factor in influencing Ethiopia's trade negatively. On the other hand, Ethiopia's export and import trade are not found to be influenced to by common border . The country specific effects show that Ethiopia could do better by trading more with Comesa member countries and newly emerging economies of Asia such as Hong Kong, Singapore and Yemen as well as European countries like Turkey and Russia.