EU integration and structural gravity: A comprehensive quantification of the border effect on trade

Abstract

This study delivers a comprehensive picture of EU trade integration in manufactured goods using a structural gravity framework together with a flexible two-step estimation approach. With panel data, time-invariant effects on trade are typically absorbed by fixed effects. This paper shows how to include both time-variant and time-invariant effects on trade into general equilibrium counterfactual experiments. Results show that the time-invariant effects or, in other words, the initial integration degree of the incumbent EU-15 members should not be neglected as it already increased intra-EU trade shares by 70% until 1995. Since then, trade integration has not deepened for the EU-15, while trade shares among the newly joined central and eastern EU members doubled. A further deepening of the Single Market could potentially unlock another 50% increase in trade and around 3% in welfare (real income).