The Impact of Financial Openness on Economic Integration: Evidence from the Europe and the Cis

For a given year t, the gravity equation expresses trade of country i with the partner
country j (Tij) as a function of the economic size of the two countries (Y), the
geographical distance between them (D) and a set of additional geographical,
economic and environmental variables W:

^Yit^Yj t

(4) Tij, t =          exp(Wij, t )

D

Taking logs on both sides, equation (4) becomes:
(5) ln(Tij,t) =ln(Yi,tY j,t) -ln(Dij,t) + Wij,t

Following the arguments presented in Section 2, financial openness of country i (zi)
will be included in the set W. Similarly to the specification of the per-capita income
gap equation, a proxy for domestic financial depth in country i will also enter the
r.h.s. so as to disentangle the effect of financial openness from that of financial
development. Thus, the gravity equation to be estimated is:

(6) ln(T_ij,t) = β₀ +β₁ ln(Y_i,tY_j,t) +β₂ ln(D_ij,t) + β₃z_i,t + β₄q_i,t +υ_ij,t

where υ is a stochastic disturbance term, and β's are the parameters to be estimated. It
goes without saying that, whilst formally indexed by the subscript t, distanceD is
constant over time. Again, the sign and statistical significance of the coefficient β3
will provide empirical evidence on the impact of financial openness on the degree of
trade integration of country i with partner j. A statistically significant and positive
value of β3 would indicate that financial openness promotes trade integration.

Drawing on the gravity literature, equation (6) will also be expanded by adding some
dummy variables to the set W in order to isolate specific trade facilitating conditions.

3.2. Estimation methodology and data

Sample and methodology

Equations (3) and (6) are estimated on two groups of countries. The first group
includes only formerly planned economies (so-called emerging economies). The

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