In this paper, we estimate a gravity equation properly accounting for omitted exporter and importer's overall trade resistance, through country-yearly dummies for exporter and importer countries. We find that the omission of time-varying multilateral trade resistance terms in the estimation of a gravity equation introduces important biases in the results, although correcting them means we can only compute differences between actual and predicted export shares, instead of levels, as usually done. An application to the calculation of trade potentials in the Euromed region (Southern and Eastern Mediterranean countries)shows that the omission of time-varying multilateral trade resistance terms greatly influences the computation of export potentials as well as the estimated effect of signing a free trade agreement. Overall, we find that, except for Algeria, Jordan and Lebanon, Euromed countries' share of exports to the EU as a whole is at, or slightly above, those predicted by a correctly-specified gravity model, although the share of exports to some individual EU countries is significantly below the predictions of the gravity model. Except for those three countries, we find significant opportunities for export growth to the US, instead.

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Documentos de Trabajo. N.º 0810 2008The Working Paper Series seeks to disseminate original research in economics and finance. All papers have been anonymously refereed. By publishing these papers, the Banco de España aims to contribute to economic analysis and, in particular, to knowledge of the Spanish economy and its international environment.The opinions and analyses in the Working Paper Series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the Banco de España or the Eurosystem.The Banco de España disseminates its main reports and most of its publications via the INTERNET at the following website: http://www.bde.es.Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

The Working Paper Series seeks to disseminate original research in economics and finance. All papers have been anonymously refereed. by publishing these papers, the banco de españa aims to contribute to economic analysis and, in particular, to knowledge of the spanish economy and its international environment.The opinions and analyses in the Working paper series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the banco de españa or the eurosystem.The banco de españa disseminates its main reports and most of its publications via the inTerneT at the following website: http://www.bde.es.reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged. This paper highlights the importance of product differentiation and endogenous r&d in determining the optimal r&d policy, in a model where investment in cost reducing r&d is committed before firms compete in a differentiated-goods third-country export market. R&D is always taxed in oligopolies for high degrees of product differentiation. For lower degrees of product differentiation the duopoly is subsidized or the government remains inactive. in contrast, the monopoly is always subsidized. The government with a duopoly may be active or inactive depending on the degree of product differentiation. Thus, we may observe a reversal in the sign of the optimal r&d policy if the degree of product differentiation changes or, alternatively, if there is a change in the number of firms. Similar qualitative results hold if trade policy uses output subsidies, instead of r&d promotion.