metadata: authors: 0: author: Djankov, Simeon
1: author: Freund, Caroline
count: Russian Federation,Lithuania,Latvia,Moldova,Kyrgyz Republic,Kazakhstan,Tajikistan,Turkmenistan,Ukraine,Uzbekistan,Estonia,Georgia,Belarus,Armenia,Azerbaijan
docna: 0: docna: Disintegration and trade flows : evidence
            from the Former Soviet Union
docty: Policy Research Working Paper
subtopic: Trade Policy,International Trade and Trade Rules,Rules of Origin,Trade and Services,Transport Services,Financial Sector Policy,Trade and Multilateral Issues
teratopic: International Economics and Trade
abstracts: cdata!: The authors study the effects of trade
            barriers and the persistence of past linkages on trade flows
            in the former Soviet Union. Estimating a gravity equation on
            trade among and between nine Russian regions and 14 former
            Soviet republics, they find that Russian regions traded 60
            percent more with each other than with republics in the
            reform period (1994-96). By contrast, the Russian regions
            did not trade significantly more with each other than with
            republics in the pre-reform period (1987-90). The results
            suggest that the bias toward domestic trade in the reform
            period is primarily the result of tariffs. In addition, past
            linkages-such as infrastructure, business networks, and
            production and consumption chains-have limited the
            reorientation of trade.
geo_reg_key: 517208,517198,545134,82689,517190,517191
repnme: repnme: Disintegration and trade flows : evidence
            from the Former Soviet Union
display_title: Disintegration and trade flows :
            evidence from the Former Soviet Union
listing_relative_url: /research/2000/06/437120/disintegration-trade-flows-evidence-former-soviet-union
topicv3: Transport m1326661 135,Trade m1326924 698,Non-Tariff Measures m1326926 778,Trade in Services m1326928 780,Financial Sector Development m1327681 1920
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: International Economics and Trade
origu: Financial Sctr Operations & Pol (OPD)
no_of_pages: 34
model_extractions: POLICY RESEARCH WORKING<sup>PAPER 2378</sup>

# **Summary** findings

Djankov and Freund study<sup>the effects of trade barriers</sup> and the persistence of past<sup>linkages on trade flows in the</sup> former Soviet Union.

Estimating a gravity equation<sup>on trade among and</sup> between nine Russian regions<sup>and 14 former Soviet</sup> republics, they find that Russian<sup>regions traded 60</sup> percent more with each other<sup>than with republics in the</sup> reform period (1994-96).

By contrast, the Russian regions<sup>did not trade</sup> significantly more with each<sup>other than with republics in</sup> the prereform period (1987-90).

The results suggest that the<sup>bias toward domestic trade</sup> in the reform period is primarily<sup>the result of tariffs. In</sup> addition, past linkages<sup>-</sup> such as infrastructure, business networks, and production<sup>and consumption chains-</sup> have limited the reorientation<sup>of trade.</sup> This paper-a product of the<sup>Financial Sector Strategy and Policy Department-is part of a larger effort in the department</sup> to promote economic liberalization.<sup>Copies of the paper are available free from the World Bank, 1818 H Street NW,</sup> Washington, DC 20433.<sup>Please contact Rose Vo, room MC9-624, telephone 202-473-3722, fax 202-522-2031, email</sup> address hvol@worldbank.org.<sup>Policy Research Working Papers are also posted on the Web at www.worldbank.org/</sup> research/workingpapers. The<sup>authors may be contacted at sdjankov@worldbank.org or caroline.l.freund@frb.gov. June</sup> 2000. (28 pages) _The Policy Research Working_<sup>_Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about_</sup> _development issues. An objective_<sup>_of the series is to get the findings out quickly, even if the presentations are less than fully polished. The_</sup> _papers carry the names of the_<sup>_authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this_</sup> _paper are entirely those of the_<sup>_authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the_</sup> _countries they represent._ Produced by the Policy Research<sup>Dissemination Center</sup>
# Disintegration and flade Flows:

# Evidence from the Former Soviet Union

Simeon Djankov World Bank Caroline Freund* Federal Reserve Board We are grateful to Don Davis, Alan Deardorff, Simon Evenett, Linda Goldberg,<sup>Jim Harrigan, Oleh Havrylyshyn,</sup> John Helliwell, David Hummels, John Rogers, Maurice Schiff, Kei-Mu Yi and<sup>seminar participants at CEPII-Paris,</sup> the Federal Reserve Board, the New York Federal Reserve Bank, and the World Bank<sup>for comments on earlier drafts.</sup> The views in this paper are solely the responsibility of the authors and should<sup>not be interpreted as reflecting the</sup> views of the World Bank, the Board of Governors of the Federal Reserve System,<sup>or any other person associated with</sup> the Federal Reserve System. Correspondence: caroline.l.freundOfrb.gov.
# 1 Introduction

Borders significantly influence trade flows, however, the reasons behind this effect remain largely unknown. Since the counter-factual (absence of borders) is typically not observable, researchers have not been able to determine whether the border effect is the result of trade barriers, past linkages, or is natural-i.e. the result of comparative advantage or tastes. The disintegration of the Soviet Union provides a unique opportunity to examine these competing hypotheses since one can observe trade flows between the same partners, both in the presence and absence of borders.

This paper offers three contributions. First, we document the adjustment in trade flows in response to the collapse of the Soviet Union and quantify the border effect. We examine bilateral trade flows among nine Russian regions and fourteen republics of the former Soviet Union (FSU) before and after the Union dissolved. Estimating a gravity equation we find that regions did not trade more with each other than with republics in the pre-reform period. In the reform period, however, Russian regions traded about 60 percent more with each other than with the republics, with the domestic bias increasing over time. Thus, the disintegration of the Soviet Union has already led to a significant domestic reorientation in trade. We also find that the elasticities of trade to income and distance, in the pre-reform period, are markedly smaller than those typically found in empirical work using the gravity equation. In the reform period, however, the elasticities are similar to those from studies of other countries. It thus appears that the decline of central planning has allowed gravity to set in, and now income and distance influence trade flows in a more standard way in the FSU.

Second, we distinguish the primary causes of the border effect. We find that the importance of the Russian border is primarily the result of trade barriers. The inclusion of tariffs in the estimation reduces the bias to where it is insignificantly different from zero. When heterogeneity 2
across countries is allowed, we find that trade flows between Russian regions and countries which signed a free trade agreement with Russia remain similar to intra-Russian trade in the reform period, implying that national borders alone have not diverted trade flows in the FSU.

Third, our results also suggest that slow adjustment of production and of infrastructure has limited trade reorientation. Using past trade to proxy for linkages developed when the Soviet Union was integrated, we find that past linkages significantly influence current trade. Since past trade was centrally planned it is unlikely that we are picking up other unobserved persistent variables, such as tastes or comparative advantage. As linkages with other republics continue to atrophy, the domestic trade bias will increase to well over the 60 percent we estimate currently.

Our estimate of the border effect is significantly lower than similar estimates using OECD data, despite greater trade barriers in the FSU. Using inter-provincial and province-state trade data, McCallum (1995) and Helliwell (1996) find that in 1990 Canadian provinces traded about twenty times more among themselves than with U.S. states. More recently, Helliwell (1998) estimates the bias to be twelve in 1996 following the preferential trading agreement (PTA) between the two countries.<sup>1</sup> Wei (1996) and Helliwell (1998) estimate that the domestic trade bias among OECD countries ranges from three to twelve.<sup>2</sup> One explanation that is consistent with both sets of results is that past linkages have led to a continued domestic orientation in trade in the OECD, despite falling trade barriers, and sustained integration in the FSU in spite of rising trade barriers.

**'An** alternative way to evaluate the border effect is with price data. Engel and Rogers (1996) examine the relative price variability of similar goods among cities in Canada and the United States. They find that relative price variability between cities is significantly greater when a border is crossed.

2Wei (1996) develops a technique to estimate the domestic bias in trade using input-output tables to estimate internal trade for countries without regional data. He assumes that internal trade distances are one-quarter the distance between a country and its nearest trade partner, to estimate the border effect. One problem with this method is that the border estimate is proportional to the assumed internal trade distance.

3
The paper is organized as follows. Section 2 reviews the literature on the border effect. Section 3 discusses the empirical specification and results. Section 4 concludes.

# 2 Why do borders matter?

Empirical studies on the effects of borders are uniform in finding a high domestic bias in trade. It remains a puzzle as to why borders matter so much. Three hypotheses have been put forward in the literature: (i) international trade barriers, (ii) natural partners, and (iii) historical linkages. The first implies borders matter because of tariffs, quotas, and other barriers to trade. Trade barriers raise the relative price of imported goods and lead to a consumption bundle biased towards domestically produced goods.

Alternatively, borders may be endogenous. Owing to comparative advantage, tastes, or technology, regions within a border may simply be natural trade partners. Borders tend to be formed around populations that are relatively homogeneous, have similar tastes, and in which the regional economies are linked. These associated regions may create borders to protect themselves from external shocks.

Finally, cross-border trade may be relatively small because past isolation has led to domestically oriented infrastructure and production. For example, highways, rail systems, legal and regulatory institutions, business networks and consumer networks, and telecommunications systems all differ across countries and thus may increase the costs of international trade relative to domestic trade. Assuming infrastructure is costly to adjust, a history of isolation will depress trade while historical linkages to other nations will help promote current trade. Similarly, if capital adjustment across industries is costly then an economy with primarily domestically oriented industry will adjust slowly to external pressure.

4
A growing empirical literature finds that historical linkages are important determinants of trade. Frankel, Stein and Wei (1995) show that countries with colonial links and countries with common language trade more with each other than the gravity model predicts. Frankel (1997) surveys the literature on the dissolution of (British and French) colonial links and the breakup of federations (the Austro-Hungarian Empire, the Malay Federation, Czechoslovakia, the former Soviet Union) and finds "a tendency for established bilateral trade ties to change relatively slowly" (p.126). He notes, however, the tenuous nature of these findings derived from trade intensity ratios which do not control for the effects of distance and income. Eichengreen and Irwin (1998) find that lagged bilateral trade is significant in determining current bilateral trade in a large cross-section of countries, after controlling for inpome and distance, and interpret this as evidence that past linkages adjust only slowly to new conditions. Also indicative of the importance of historical linkages, Freund (2000) finds that the founding members of the European Union created a well-integrated market among themselves and then maintained stronger trade links with each other than with countries that joined later. There was no evidence of a bias in trade towards the original members before the common market was formed.

# 3 Empirical specification

The FSU provides a unique case study because in the pre-reform period infrastructure and technology were uniform across regions and republics, there were no trade barriers, and trade was centrally planned. In the reform period, borders have been erected, large tariffs are in place, and central planning has been abandoned; but, transport costs, infrastructure, and technology are likely to be slow to change. This allows us to examine how past integration affects current trade and how tariffs influence trade, when there are no differences in infrastructure and history. That is, any correlation 5
between pre-reform trade and current trade, after controlling for size and distance, must be largely a result of historical linkages and not the result of unobservables such as comparative advantage and tastes.

# 3.1 The Data

We examine trade among 9 regions in Russia and 14 former republics of the Soviet Union before and after disintegration. The trade data are from the Russian State Statistical Committee and the World Bank and include bilateral trade flows among regions and republics, in U.S. dollars. Income figures are from the World Bank and are also in U.S. dollars. Distance is taken from the Russian Ministry of Transport tables as the shortest road distance in kilometers between regional and/or republican centers. Unweighted average ad-valorem tariff rates are published by the EBRD. Population figures are from the World Bank. (See the Appendix for a detailed description of the data and a map of the region.) There are two weaknesses in the data. First, because of central planning, the pre-reform trade values are not market values. Since we are comparing across regions and republics all of which are within the same country and subject to the same prices, they are nevertheless valuable estimates of relative trade between partners. The second problem is the presence of barter trade, which became quite common in the FSU in the reform period. Barter trade is recorded in the dataset, however the prices at which it is recorded are likely to be biased downwards in order to avoid taxes and tariffs. Again since we are comparing trade within the FSU, this is less of a problem because barter trade is likely to be as prevalent among regions as between regions and republics (see Appendix). Therefore, although the magnitudes of trade are likely to be distorted, there is no reason to think that relative trade among parties within the FSU is systematically biased. If we included non FSU countries in the study, these problems would distort relative trade as well.

6
<!-- Start of picture text --> 0.9<br>0.8 -<br>0.7-<br>0.6<br>0.5l 11989<br>0.4 -*N1996<br>0.3<br>0.2<br>0.1<br>0<br>co c 0o S c c .a 51~ a S C<br>e s2 co e f c o ta .5. S -o<br>ui - - ~ 0 0cc0<br><~~~~~ E N.<br><!-- End of picture text --> Figure 1: Exports to other FSU countries relative to total exports Figure 1 shows each country's share of total excports that go to other FSU countries. FSU export shares have declined for all but three former members-Azerbaijan, Belarus, and Uzbekistan. This suggests that a significant reorientation of trade away from FSU countries has occurred since the disintegration of the FSU.

Our interest, however, lies primarily with the domestic reorientation of trade within Russia, so we also document the share of total FSU trade for each region and each republic that is with Russia. In the pre-reform period, on average 65 percent of each region's trade with the FSU countries was with other Russian regions and trade shares were flat (Figure 2). In the reform period, the share of trade that is inter-regional rises to about 80 percent, for all regions. The republics' share of FSU trade with the Russian regions is about 50 percent in the pre-reform period and fairly constant (Figure 3). In the reform period, regional trade shares change dramatically.

7
<!-- Start of picture text --> 0.9<br>0.8 - North<br>0.7 _- rtNorthw est<br>0.6 ' - Central<br>0.5 -- ' Chernozyom<br>0.4<br>0.3 -N- North Caucases<br>0.2 Y Volga<br>0.1 -I Vola-Vyatka<br>0 - Ural<br>_________0 co )0 - 0 0 0 0 -Far ____________CEast<br><!-- End of picture text --> Figure 2: Share of total FSU trade with Russia by region While the movement in trade shares over time is suggestive of an increasing domestic bias in trade, shares alone do not tell us whether regions trade relatively more among themselves, we need to control for standard determinants of trade. For example, the increased Russian trade share among the regions may be the result of relatively higher income growth. Next, we use a simple gravity specification which is comparable to the models in McCallum (1995) and Helliwell (1996, 1998) to estimate the extent of domestic bias in trade. After estimating the benchmark model, we account for country specific effects, tariffs, and history.

# 3.2 The benchmark specification

We use a gravity equation to examine trade within Russia. The gravity equation describes trade between two parties as proportional to the product of their incomes divided by the distance between them. Theoretical models supporting the gravity equation are numerous. In particular, the monopolistic competition model and Heckscher-Ohlin model of trade both produce estimating 8
<!-- Start of picture text --> + Arnenian _<br>_ Azerbaijan<br>0.9 Belarus<br>0.8 ---X Estonia<br>0.7 -N- Georgia<br>0.6 ;*- Kazakhstan<br>0.5 - Kyrgistan<br>0.4 - Latvia<br>0.3 - Li_huania<br>0.2 -*-Nbidova<br>0.1 -'--- Tajildstan<br>0 I l l l l l l ^ Turkmenistan<br>- t kraine<br>-*- Uzbekistan<br><!-- End of picture text --> Figure 3: Share of total FSU trade with Russia by republic equations similar to the gravity equation describing bilateral trade flows (Deardorff 1998).

We estimate a gravity equation on 1987-1990 and 1994-1996 trade flows among and between 9 Russian regions and the 14 republics of the Soviet Union. The regression equation for each year in log levels is:

# _TRADEi =_ a _+ oYi + I3Yj + 32DISTij + j3RUSSIA + u,i_

where _TRADEij_ is the log of shipments from region i to region _j, Yi_ and Yj are the logs of gross regional product in regions i and j respectively, _DISTij_ is the log of the distance from i to j, _RUSSIA_ is a dummy equal to one for intra-Russian trade and zero for region to republic trade, and _uij_ is the error term, which we assume is uncorrelated across observations. The _RUSSIA_ variable pools all effects that make cross-border trade different from domestic trade (Table 1).

The coefficient on the _RUSSIA_ dummy rises noticeably from the pre-reform period to the reform period. The coefficient of 0.46 on _RUSSIA_ in 1996 is highly significant and implies that 9
<!-- Start of picture text -->
1.6<br>1.4<br>1.2<br>0.8<br>0.6<br>0.4<br>0.2<br><!-- End of picture text -->

Figure 4: Domestic Bias in Russian Trade Russian regions traded 58 percent more with each other than is predicted by the model _(exp_ 0.46 = 1.58). In the pre-reform period, the regions did not trade more with each other. In fact, though not significant, the coefficient is negative in each year. Figure 4 documents the estimated bias towards intra-national trade in Russia over time as calculated from the estimated coefficient on _RUSSIA_ in the benchmark model. Russian trade displays an increasing domestic bias after 1994.3 The insignificant (and negative) bias in trade between Russian regions in the pre-reform period is not surprising given that trade was centrally planned across all of the FSU and there were no borders. The move away from central planning is also noticeable in Table 2. In all specifications we 3 We also organize the data into two panels, a pre-reform period (1987-1990) and a reform period (1994-1996) and use OLS and random effects (not reported). The regression is based on equation (1), with an added time dimension. These results confirm our earlier estimates-the coefficient on _RUSSIA_ was not significant in the pre-reform period **and** in the reform period the OLS results estimate the bias to be 50 percent and the random effects estimate the bias to be 60 percent.

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find that the elasticity of trade with respect to income and distance increases after disintegration. For example, the coefficient on distance more than doubles in magnitude from -0.42 to -1.16. This change is hardly surprising - pre-reform trade over long distances was heavily subsidized. The coefficients in the reform period are much closer to the coefficients typically found on estimates of the gravity model.<sup>4</sup> This suggests that gravity has set in and that trade patterns in the FSU are now determined in a similar way to the rest of the world.

Since GNP is not exogenous with respect to trade we also use population to instrument for GDP. The results are shown in Table 2. The coefficients on income are higher. The reorientation within Russia is still evident from the change in significance of the Russia dummy over time. Russian regions are significantly less likely to trade with one-another in the pre-reform period and this bias disappears in the reform period.

# 3.3 Allowing **for heterogeneity across countries**

Non-tariff barriers, currency variability, and differences in wages and prices across regions and republics may affect trade. To allow for this possible heterogeneity, we split the sample into two panels-pre-reform and reform-and use country fixed effects in the estimation. We exclude interrepublic trade from the sample and estimate equation (2) separately for the pre-reform and reform periods,

## _TRADE,j,t = at_ + _I3yij + 3lYit + 32Yjt + / 3 DISTij + uij,_

where _-yij_ is a country dummy. The dummy for Armenia, for example, is one when Armenia is either an exporter or an importer. Since inter-republic trade is excluded and all republics are dummied 4 Most comparable is the Canada U.S. study since trade in North America is also land-based trade. McCallum 1995 and Helliwell 1998 find the elasticity of trade to distance on Canada-U.S. data is between -1.23 and -1.62. Helliwell finds the elasticity on OECD trade to be between -0.87 and -1.02 in 1992.

11
<!-- Start of picture text --> 9<br>8 -<br>7<br>6<br>5 j pre-reform<br>4 i reform<br>3<br>2<br>i w a 1.~~~~~~~~~~~~~~~~~~~~~~~1 c|j3i< oe C<br><!-- End of picture text -->

Figure 5: Russian bias against former republics out, the coefficient on the Armenia dummy represents how much more or less Armenia trades with the Russian regions relative to how much the Russian regions trade among themselves. In the pre-reform period, the Russian bias against Armenia is 0.73 (1/exp(O.31) = 0.73), implying the regions trade about 27 percent less with each other as compared to with Armenia. In the reform period, they trade 70 percent more with each other than with Armenia (a bias of 1.7). A coefficient of zero means that there is no bias (the bias equals 1). Figure 5 shows the bias against each former republic in both periods. In the pre-reform period, seven of the republics trade significantly more with Russia than is predicted by the model, three do not trade significantly more or less, and the remaining four trade significantly less.

Earlier results suggested that the Russian regions did not trade more with each other in the pre-reform period, yet traded more with each other than with other FSU members in the reform 12
period. This is confirmed here, with no single country driving the results. Trade between the Russian regions and all republics, except Kazakhstan, fell from the pre-reform to the<sup>reform period.</sup> The countries that experienced the greatest declines in trade with the Russian regions are Georgia, Turkmenistan, Lithuania, Latvia, Azerbaijan and Armenia, in that order. Located<sup>directly south</sup> of Chechnya, Georgia, Armenia, and Azerbaijan suffered as a result of the Chechen war. Lithuania and Latvia have consciously followed a policy of integration into Western<sup>Europe.</sup> The coefficients on Belarus and Kazakhstan are both positive in the reform period, suggesting that both countries still trade at least as much with Russian regions as regions trade among themselves. These two countries alone signed a free trade agreement with Russia. This implies<sup>that the</sup> Russian bias in trade may be largely a. result of trade barriers.

# 3.4 Estimating the effect of tariffs **and** adjustment costs

The benchmark model used to estimate the trade bias (equation (1)) includes<sup>distance as a proxy</sup> for transport costs and a dummy variable _(RUSSIA)_ to estimate possible excess trade between Russian regions. The question is how to interpret the positive coefficient on the<sup>dummy variable</sup> in the reform period. It could be picking up other parts of trade costs besides distance related transport costs or it could be picking up trade barriers. Alternatively, it may represent<sup>differences</sup> in factor endowments, tastes, or technology.

In this section we attempt to examine the effect of tariffs and past linkages on trade.<sup>We</sup> incorporate tariff levels into the benchmark equation as the log of one plus the<sup>ad-valorem tariff</sup> 5We perform further robustness tests by looking at trade with other regions versus trade with republics for each region. Each regression is run on a region's trade with all of its trading partners.<sup>For all regions we find that trade</sup> with the other regions relative to the republics expanded - no single region is driving<sup>our results.</sup> 13
rate in the importer country _(TARIFF)._<sup>_6_</sup> Two PTAs were ratified in the reform period: one between Russia, Kazakhstan, and Belarus and another between<sup>Estonia, Latvia, and Lithuania, so</sup> the ad valorem tariff is zero whenever trade is between any of these<sup>country pairs or among regions.</sup> The bias towards Russian goods, either as a result of non-tariff barriers,<sup>preferences, or price and</sup> wage differentials is now controlled for by the _RUSSIA_ dummy.

The results are reported in Table 2. The inclusion of the tariff<sup>variable eliminates the significance</sup> of _RUSSIA._ This indicates that trade policy is the main cause of lower trade<sup>among regions and</sup> republics. The coefficient can be interpreted as the elasticity<sup>of trade with respect to the tariff. The</sup> coefficients on the tariff rate of -1.2 in 1994 and -1.65 in 1996 imply<sup>that the elasticity of trade to</sup> the tariff is increasing in absolute value over time. This is consistent<sup>with there being adjustment</sup> costs in reorienting production and infrastructure. The impact<sup>on trade is relatively small when</sup> the tariff is initially imposed, as time goes on and infrastructure<sup>and production are reoriented, the</sup> magnitude of its effect rises.

Next we also include a variable describing past linkages _(LINKS)._<sup>Past linkages exist through-</sup> out the FSU as a result of central planning. For example, there are<sup>highly integrated production</sup> and consumption chains, infrastructure for trade, and business networks<sup>all of which are likely to</sup> change slowly, and all of which lead to greater current trade than in their absence.

We assume that the current linkage between two areas is an increasing<sup>function of their past</sup> trade:

# _LINKAGEijt = F(Mijt-1, Mijt-2 Mijt-3,..)._

The intuition is that greater trade in the past generated more investment<sup>and hence a larger</sup> capital stock (in terms of production and infrastructure) geared<sup>toward that trade. For a model</sup> 6This format can be derived from a model where tariflf enter multiplicatively, such as a differentiated goods model.

14
that develops a similar intuition see Bougheas et. al. (1999). They show that if infrastructure lowers transport costs, then infrastructure and the volume of trade will be positively correlated in a Dornbusch-Fischer-Samuelson model. While they model specific infrastructure for transport, we have in mind a more general notion of linkages through physical infrastructure, production chains, and business contacts.

As a result of central planning, trade in the pre-reform period was very similar across years, as evidenced by Table 1. We thus assume that linkages will be positively correlated with centrally planned trade from the pre-reform period. This implies that we can include pre-reform trade patterns as a measure of current linkages for trade.

The regressions including past trade are reported in the final three columns of Table 3. The significance of 1987 trade in the regression equation for 1996 implies that a great deal of current trade is still determined by past trade patterns. That is, past linkages have limited the bias on current trade. Specifically, the results imply that 1 percent increase in trade in 1987 leads to about half of one percent increase in current trade.

One problem with including past trade is that it may also be correlated with current trade because of other persistent variables that are not included in the regression equation, such as endowments or technology, but that are not related to past linkages.<sup>7</sup> This is likely to be less of an issue in this data because trade in the pre-reform period was centrally planned and not based on comparative advantage. In addition, the countries in our study were trade partners by default, trading little with countries outside the Union. Therefore, disintegration implies that the set of countries over which comparative advantage is determined is greater. In addition, economies have changed dramatically since 1992, some economies have grown while others have shrunk, countries 7Wonnacott (1998) highlights this problem in his discussion of Eichengreen and Irwin's (1998) paper on trade flows, which was the first to incorporate past trade into the gravity equation.

15
now have different currencies, and prices are no longer equalized across regions and republics.

Still, as a robustness check, we use the fitted values of past trade from the simple gravity equation in the regression (Column five of Table 3). The results remain robust implying that a significant amount of current trade is determined by past linkages.

# 3.4.1 Interpretation and Implications **for the Future**

The results in this paper show that trade has been reoriented within Russia, primarily as a result of trade barriers, and that trade flows within the FSU are still significantly impacted by past linkages. We have also shown that the elasticity of trade with respect to tariffs increases over time, likely as a result of a reorientation of production, infrastructure, and networks. This implies that the Russian bias we estimate will continue to increase over time. Decreasing trade between Russian regions and republics will affect production, infrastructure maintenance and development, and business networks. As these linkages for trade deteriorate, the cost of international trade will increase, which will cause trade between FSU countries to decline further.

At present this process is likely show up in only marginal improvements or neglect of existing infrastructure. To examine the extent to which this process has begun, we first examine passenger train speed within the FSU as a proxy for investment in infrastructure that links regions to republics, and then we discuss how nascent projects in the FSU countries are likely to alter international linkages.<sup>8</sup> Using train schedules between FSU countries and Russian regions, we find that trains got faster between most Russian regions from 1989 to 1996, and trains to the former republics slowed. Table 4 reports the average percent change in time of travel between and among regions and republics from 8Train schedules for 1989 and 1996 are from the National Railways archives in Moscow.

16
1989 to 1996. While travel times between regions and republics and among republics lengthened; travel times among the Russian regions were nearly all shorter in 1996 as compared with 1989 (last column in Table 4). For example, a train from the North region to the republics took 4.9 percent longer on average in 1996 as compared with 1989; but a train from the North to the other Russian regions took 2.0 percent less time on average in 1996 than in 1989. The largest travel time increase was between Chernozyom and Uzbekistan; it took 41 percent longer to travel between the two capitals in 1996. The sharpest decline was between Central Russia and Chernozyom; it took 7.2 percent less time to travel between the two capitals in 1996 as compared with 1989. This suggests that trains in Chernozyom have been reoriented towards Moscow and away from the southern route to Uzbekistan.

Changes in travel times were accompanied by a change in the frequency of service. The frequency of trains traveling between Russian regions have for the most part remained constant or improved, but train service from regions to republics has become less frequent. These results suggests both that infrastructure between regions and republics is deteriorating and that connections for business travel across national borders are less frequent. While this is probably partially a result of declining trade, it is also likely to increase the costs of international trade and hence facilitate the reorientation in trade.

Reorientation of infrastructure is also evident in the new projects and agreements that have emerged in most FSU countries. One striking example is the move of the Kazakh capital from Almaty (in the south) to Astana (in the north) and the construction of a highway and a railroad to link the two cities. Latvia and Estonia are also building a fast train link between their capitals. Belarus and Russia recently agreed to deeper economic and political integration, the accord includes currency unification and enacting unified customs regulations. These projects and agreements are 17
likely to affect trade patterns in the FSU in the years to come. As these new linkages are developed and past linkages atrophy, the domestic bias in Russian trade will surely increase.

# 4 Conclusions

In the days of the Soviet Union, trade was centrally planned, trade links between regions and republics were very strong, and the regions did not trade more with each other than with the republics. The collapse of cerntral planning along with the disintegration of the Soviet Union have induced a change in the determinants of trade. As gravity has set in, the elasticities of trade to income and distance have risen and are now similar to those found in the rest of the world. In addition, an increasing bias towards domestic trade in Russia has developed. Specifically, we show that Russian regions traded 60 percent more with each other than with former republics in 1996. This bias is primarily due to the erection of tariff barriers.

The border effects we estimate are. lower than in previous studies because infrastructure and production have not been domestically reorganized in the short period since the collapse of the Soviet Union. That is, the intra-national bias has been mitigated through strong historical linkages that Russian regions have to former Soviet republics and costs of adjustment to redirecting trade and building new infrastructure. The erection of political borders, however, will likely be followed by the development of new economic borders. This implies that the domestic bias in Russia (and in the new republics) will grow over time.

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