FOREIGN TRADE UNIVERSITY

FACULTY OF INTERNATIONAL ECONOMICS

**********

MID-TERM REPORT

TOPIC: THE IMPACT OF PURCHASING POWER PARITY ON THE

TOTAL TRADE VALUE OF ASIA-PACIFIC COUNTRIES
DURING THE PERIOD 2002-2023

Subject: ECONOMETRICS
Class code: KTEE309(2526.1-GD2).2
Instructor: MA. Nguyen Thuy Quynh
Group Number: 01

Ha Noi, December 2025

 TABLE OF CONTENTS
WORK EVALUATION TABLE.......................................................................................5
LIST OF TABLES............................................................................................................. 6
ACKNOWLEDGEMENT.................................................................................................7
ABSTRACT........................................................................................................................8
INTRODUCTION..............................................................................................................9
1. Rationale of the Study................................................................................................... 9
2. Research Aim and Objectives..................................................................................... 10
3. Research Objects and Scope........................................................................................11
4. Research methods........................................................................................................ 12
5. Research Structure...................................................................................................... 12
CHAPTER 1: THEORETICAL BASIS AND LITERATURE REVIEW.................. 13
1. Theoretical Basis.......................................................................................................... 13
1.1. Purchasing power parity theory (PPP theory).................................................... 13
1.2. Gravity model of trade.......................................................................................... 15
1.3. Institutional economics - The role of political stability...................................... 17
1.4. Value-added production theory............................................................................ 18
1.5. Definition and theoretical foundation of variables in the model....................... 18
1.5.1. Dependent variable.......................................................................................19
1.5.2. Explanatory variables...................................................................................19
2. Literature Review........................................................................................................ 21
2.1. International Literature Review...........................................................................21
2.2. Review of Research in Asia-Pacific..................................................................... 23
2.3. Research Gap........................................................................................................25
3. Research Hypothesis Development.............................................................................26
3.1. The Impact of Purchasing Power Parity on Total Trade Value..........................26
3.2. The Impact of other indicators on Total Trade Value......................................... 26
3.2.1. The Impact of Political Stability on Total Trade Value................................26
3.2.2. The Impact of Trade ín Services on Total Trade Value................................ 27
3.2.3. The Impact of Manufacturing Value Added on Total Trade Value...............27
CHAPTER 2: RESEARCH METHODOLOGY AND ECONOMETRIC MODEL 30
1. Research Methodology................................................................................................ 30
1.1. Data Collection Methods......................................................................................30
1.2. Data Analysis Methods.........................................................................................30
2. Building the Regression Model................................................................................... 32

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 2.1. Model Specification.............................................................................................. 32
2.1.1. Population Regression Model.......................................................................32
2.1.2. Sample Regression Model.............................................................................33
2.2. Explanation of Variables, Units and Expected Impact on the Dependent
Variable........................................................................................................................ 33
3. Data Description...........................................................................................................35
3.1. Data Sources.........................................................................................................35
3.2. Descriptive Statistics.............................................................................................35
3.3. Correlation Analysis.............................................................................................36
CHAPTER 3: ESTIMATION, MODEL TESTING AND STATISTICAL
INFERENCE.................................................................................................................... 39
1. OLS Regression Result................................................................................................ 39
1.1. Interpretation of Regression Coefficients............................................................40
1.2. Coefficient of determination R2...........................................................................41
2. Model Defect Test.........................................................................................................41
2.1. Multicollinearity Test............................................................................................41
2.2. Autocorrelation Test............................................................................................. 42
2.3. Heteroskedasticity Test......................................................................................... 47
2.4. Normality Test.......................................................................................................49
2.5. Conclusion............................................................................................................ 52
3. Hypothesis Testing....................................................................................................... 52
3.1. Test for Model Overall Significance.................................................................... 53
3.2. Hypothesis Testing for Regression Coefficients.................................................. 54
3.2.1. Test for H1: Purchasing Power Parity positively affects Total Trade Value 55
3.2.2. Test for H2a: Political Stability positively affects Total Trade Value........... 55
3.2.3. Test for H2b: Trade in Service positively affects Total Trade Value............. 56
4. Research Discussion.....................................................................................................57
CHAPTER 4: RECOMMENDATIONS AND IMPLICATIONS............................... 61
1. Maintaining Competitive Pricing through Macroeconomic Stability.....................61
2. Deepening the Manufacturing Sector and Value Chain Participation................... 61
3. Improving Logistics Infrastructure and Trade-Facilitating Services..................... 62
4. Leveraging Political Stability through Institutional Reform...................................62
5. Strengthening Regional Economic Integration......................................................... 63
CONCLUSION................................................................................................................ 64
REFERENCES.................................................................................................................65
APPENDIX.......................................................................................................................66

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 WORK EVALUATION TABLE

No. Full Name Student ID Rate Bonus Signature

1 Mai Ngọc Thư 2313150254 15.5%

2 Nguyễn Thị Khánh Huyền 2312150203 15.5%

3 Phạm Hà Chi 2412550021 17.25%

4 Nguyễn Phương Thảo 2412550108 17.25%

5 Nguyễn Hải Yến 2412550117 17.25%

6 Nguyễn Hoàng Dũng 2412550025 17.25%

4
 LIST OF TABLES

Table 2.1: Diagnostic Tests and Methods for Addressing Model Deficiencies..…30
Table 2.2: The frequency and proportion of missing values for each variable…...30
Table 2.3: Explanation of Variables………………………………………………33
Table 2.4: Expected signs of the regression coefficients…………………………33
Table 2.5: Descriptive Statistics of Variables (2002-2023)....................................34
Table 2.6: Correlation Analysis among Variables………………………………...36
Table 3.1: OLS Regression Result………………………………………………..38
Table 3.2: VIF Test Results…………………………………………….…………41
Table 3.3: Arellano-Bond Test for Autocorrelation…….………………………...43
Table 3.4: Regression with Driscoll-Kraay Standard Errors…….……………….45

LIST OF FIGURES

Figure 1.1: Research Model………………………………………………………28

Figure 3.1: The Plot of Residuals against Fitted Values………………………….47
Figure 3.2: Normal Q-Q Plot of the Regression Residuals……………………….49

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 ACKNOWLEDGEMENT
Upon the completion of this research project, we would like to extend our deepest
and most sincere gratitude to our instructor, Ms. Nguyen Thuy Quynh. We have been
constantly inspired by her invaluable guidance, unwavering enthusiasm, and profound
insights throughout this entire journey. Such expertise was instrumental in shaping the
theoretical framework and direction of this study, providing us with the clarity needed to
navigate complex analytical challenges.
While our group has dedicated significant effort, diligence, and passion to
ensuring the accuracy and depth of this project, we acknowledge that certain limitations
and shortcomings are inevitable in the research. Therefore, we sincerely welcome any
constructive criticism and professional suggestions. We view your feedback as an
essential opportunity to further refine our work and enhance the overall quality of the
study for future applications.

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 ABSTRACT
This study investigates the theoretical foundations and empirical dynamics of the
factors influencing trade performance in Asia-Pacific economies, with a particular
emphasis on the role of Purchasing Power Parity (PPP). Grounded in macroeconomic
theory and international trade theory, the research examines how price level ratio and cost
differentials shape a country’s competitiveness in international markets. Using an
analytical framework that incorporates PPP as a central explanatory variable, the study
quantifies the extent to which differences in purchasing power affect the total trade value
of Asia-Pacific countries during the period 2002-2023.
The findings provide evidence that variations in PPP can either enhance or weaken
trade capacity, depending on the direction and magnitude of price-level disparities among
economies. Building on these results, the study proposes several policy recommendations
aimed at strengthening Vietnam’s trade performance, particularly in the context of
deepening regional integration and widening cross-country cost differentials. Despite
certain data limitations, the research contributes both theoretically and practically by
enriching the understanding of export determinants and offering insights to support more
effective policy design for Vietnam’s international trade strategy.
Keywords: Purchasing Power Parity, Total Trade Value, Asia-Pacific economies,
Political Stability, Trade in Services, Manufacturing Value Added.

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 INTRODUCTION

1.​ Rationale of the Study

The Asia-Pacific (APAC) region represents one of the most dynamic and
economically influential areas in the world, encompassing a diverse group of economies
that collectively account for a substantial share of global economic activity. As of recent
estimates, the APAC region contributes approximately 45% of global GDP and around
48% of global merchandise trade, making it a central driver of international growth and
trade expansion. In addition, APAC economies attract more than 35% of global foreign
direct investment (FDI) inflows, reflecting their strategic importance in global value
chains and international production networks. (Asian Development Bank, 2019)
Emerging from decades of rapid globalization, expanding regional integration, and
technological advancement, APAC has developed into a highly interconnected economic
space shaped by extensive supply chains, competitive export-oriented industries, and
rapidly growing consumer markets. The region also hosts some of the world’s largest and
fastest-growing economies such as China, Japan, South Korea, and ASEAN member
states, representing a combined population of more than 2.3 billion people, which
reinforces its role as both a major production base and a substantial demand market.
Given its economic scale, demographic diversity, and deepening cross-border
linkages, the APAC region provides a robust empirical context for examining the
determinants of export performance, especially in relation to purchasing power
disparities, cost structures, and macroeconomic conditions that shape the competitiveness
of economies within the region.
However, the region currently encounters significant challenges, such as
geopolitical tensions, supply chain disruptions, surging inflation, and volatile exchange
rates. These monetary instabilities directly affect the relative prices of goods across
borders and complicate established notions of trade competitiveness. In this context, it is

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critical for policymakers to assess whether foundational pricing theories, such as
Purchasing Power Parity (PPP), remain valid in explaining trade flows.
In this context, our study focuses on examining “The impact of purchasing power
parity on the total trade value of Asia-Pacific countries during the period 2002-2023”.
Going beyond traditional models, this research aims to provide a comprehensive
perspective by analyzing PPP in conjunction with critical structural factors such as
Political Stability, Trade in Services, and Manufacturing Value Added within the region.
By applying advanced econometric methods to a panel of 20 economies, the study seeks
to clarify the role of PPP in shaping trade outcomes, thereby offering timely insights for
economic strategy and policy formulation.

2.​ Research Aim and Objectives

2.1. Research Aim

The primary aim of this study is to empirically investigate the impact of
Purchasing Power Parity (PPP) on the Total Trade Value of Asia-Pacific countries from
2002 to 2023, thereby clarifying the role of price competitiveness in shaping regional
trade dynamics in the post-crisis era.

2.2. Research Objectives

To achieve the general aim mentioned above, the study focuses on the following
specific objectives:
-​ To systematize the theoretical and empirical basis regarding the relationship
between Purchasing Power Parity, structural factors (including Political Stability,
Trade in Services, Manufacturing Value Added), and international trade flows.
-​ To quantify the impact of Purchase Power Parity and these control variables on the
Total Trade Value of 20 Asia-Pacific economies, employing the Driscoll-Kraay
estimator to ensure robust statistical inferences against autocorrelation and
cross-sectional dependence.

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 -​ To examine the degree to which structural factors (such as industrial capacity and
institutional stability) moderate the effect of price competitiveness on trade
performance in the region.
-​ To propose feasible policy recommendations for governmental authorities, with
specific implications for Vietnam, to leverage exchange rate strategies and
structural reforms for sustainable trade growth.

3. Research Objects and Scope

3.1. Research object

This study examines how Purchasing Power Parity (PPP) and key structural
factors jointly affect the total trade value of Asia-Pacific economies. The analysis focuses
on the relationships between relative price levels and trade performance, emphasizing
PPP as a channel through which price competitiveness influences exports and imports. In
addition to PPP, three structural control variables are included: Political Stability, Trade in
Services, and Manufacturing Value Added, which help account for cross-country
differences in structural and macroeconomic conditions. The empirical object of the study
is the total trade value of 20 Asia-Pacific countries, used as a measure of overall trade
performance.

3.2. Research scopes

Time scope: The study investigates the impact of PPP differences on the total trade
value of Asia-Pacific countries during the period from 2002 to 2023 and proposes policy
implications extending to 2025. Secondary data used in the analysis are collected for the
years 2002-2023.
Spatial scope: The research focuses on the economies within the Asia-Pacific
region, with particular emphasis on 20 APAC member economies including Australia,
Brunei Darussalam, Cambodia, China, Fiji, Hong Kong (SAR China), Indonesia, Japan,
the Republic of Korea, Lao PDR, Macao (SAR China), Malaysia, Mongolia, New

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Zealand, Papua New Guinea, the Philippines, Samoa, Singapore, Thailand, and Vietnam,
which was approached from a macroeconomic and international trade perspective.
Content scope: The study examines PPP as the representative factor reflecting
price level ratio and its significance in shaping trade performance across Asia-Pacific
economies.

4. Research methods

The authors employ a quantitative approach using a multiple linear regression

model estimated by Ordinary Least Squares (OLS) on panel data.
The dataset covers 20 countries in Asia-Pacific economies over the period
2002-2023, with annual observations collected from World Bank. The dataset is
subsequently processed and cleaned, stationarity of the time-series variables is examined,
and the independent and dependent variables are specified prior to estimating the
regression model.
The quantitative analysis is implemented in Stata, which is used to estimate the
regression coefficients and evaluate the statistical significance of the explanatory
variables. The regression results provide robust empirical evidence on how Purchasing
Power Parity (PPP), Political Stability, Trade in Services, and Manufacturing Value
Added shape Total Trade Value in Asia-Pacific economies, thereby providing a
quantitative basis for the policy recommendations proposed for Vietnam and other
export-oriented economies in the region.

5. Research Structure

The report is divided into 4 chapters:

Chapter 1: Theoretical Basis and Literature Review
Chapter 2: Research Methodology and Econometric Model
Chapter 3: Estimation, Model Testing, and Statistical Inference
Chapter 4: Recommendations and Implications

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 CHAPTER 1: THEORETICAL BASIS AND LITERATURE REVIEW.

1. Theoretical Basis

1.1. Purchasing power parity theory (PPP theory)

According to “Policy and Theory of International Finance” (2012) by Steve
Suranovic, an associate professor of economics and international affairs at the George
Washington University (GW) in Washington, DC, purchasing power parity (PPP) is a
theory of exchange rate determination and a framework for comparing the average cost of
goods and services across countries. The theory assumes that the behavior of importers
and exporters-driven by cross-country price differentials-induces adjustments in the spot
exchange rate. From another perspective, PPP suggests that transactions recorded in a
country’s current account influence the value of its exchange rate in the foreign exchange
(Forex) market. This contrasts with interest rate parity theory, which assumes that
investor behavior-reflected in capital account transactions-drives exchange rate
movements. PPP theory is grounded in an extended and modified version of the “law of
one price” applied at the aggregate economic level. To fully explain the theory, it is useful
to begin by reviewing the underlying concept of the law of one price.
The Purchasing Power Parity (PPP) theory was developed by Gustav Cassel
(1918) to explain that exchange rates adjust to equalize the purchasing power of
currencies across countries. Cassel (1918) argued that if a basket of goods has different
prices in two countries, trade flows and exchange rates will adjust to bring price levels
back to equilibrium.
Krugman et al. (2018) assert that PPP serves as an essential foundation for
explaining relative prices and international competitiveness. When domestic price levels
are lower than global price levels (PPP<1), goods become relatively cheaper, thereby
increasing foreign demand for imports. Conversely, a higher PPP indicates more
expensive domestic goods, which reduces demand for exports. Dornbusch (1985)
emphasizes that domestic prices directly influence competitiveness through the exchange

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rate pass-through mechanism. Therefore, PPP functions as a key indicator in explaining
export performance.
In the case of Asian economies, according to Fibre2Fashion (2024), lower price
levels constitute an advantage that enhances competitiveness for labor-intensive sectors
such as textiles, footwear. Thus, examining the impact of PPP on export value carries
both theoretical and empirical significance.
In addition to the traditional PPP framework, the Balassa-Samuelson model
(Balassa, 1964; Samuelson, 1964) provides an important theoretical refinement that helps
explain persistent deviations from purchasing power parity across countries. The model
argues that differences in productivity growth between the tradable and non-tradable
sectors are a fundamental driver of cross country price level differentials, which PPP
alone cannot fully account for.
According to the Balassa-Samuelson hypothesis, countries that experience rapid
productivity growth in the tradable sector, such as manufacturing, electronics, or export
oriented industries, tend to exhibit higher wages in both tradable and non-tradable
sectors. Because productivity in the non-tradable sector does not increase as quickly,
rising wages lead to higher prices of non-tradable goods and services, causing the overall
domestic price level to rise. As a result, the real exchange rate appreciates, even when
nominal exchange rates remain stable.
This mechanism implies that fast growing economies naturally have higher price
levels, not because of inflationary pressure or loss of competitiveness, but because of
structural productivity differences. Consequently, the Balassa-Samuelson model provides
a structural explanation for why PPP may systematically underestimate the true
equilibrium exchange rate for developing or rapidly industrializing economies.
For Asian export-oriented economies, such as China, Vietnam, Malaysia, and
Thailand, the Balassa-Samuelson effect is particularly relevant. Rapid productivity
improvements in manufacturing have contributed to sustained increases in wages and
non-tradable prices, creating long-run deviations from PPP (Balassa, 1964; Samuelson,
1964). Nevertheless, these economies continue to maintain strong international

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competitiveness due to productivity-driven cost advantages in the tradable sector
(Krugman et al., 2018). Integrating the Balassa-Samuelson framework into the analysis
therefore helps contextualize why PPP dynamics influence export performance
differently across development stages (Obstfeld & Rogoff, 1996).
1.2. Gravity model of trade
Tinbergen (1962) and Poyhonen (1963) were the first to apply the gravity model to
analyze international trade among European countries. The model posits that bilateral
trade flows between two nations are positively related to their economic size (measured
by GDP or GNP) and negatively related to trade costs. Anderson (1979) and Anderson &
van Wincoop (2003) later provided a robust theoretical foundation for the model,
emphasizing the role of multilateral trade resistance.
The gravity model is one of the most important empirical analytical tools in
international trade research. Originating from its analogy to Newton’s law of gravitation
(Tinbergen, 1962; Poyhonen, 1963), the model assumes that trade flows between two
countries are proportional to their economic size and inversely proportional to
geographical distance. In the context of trade analysis, the GDP of the exporting country
reflects production capacity, whereas the GDP of the importing country represents the
scale of market demand. Geographical distance between the two nations is regarded as a
proxy for transaction costs, including transportation costs, shipping time, and other
natural barriers.
Seminal studies such as Frankel (1997), Rose (2000), and Anderson & van
Wincoop (2003) expanded and strengthened the theoretical underpinnings of the model,
showing that in addition to fundamental economic and geographic variables, numerous
other factors significantly influence trade value. These factors include population size,
land area, level of economic development, and dummy variables capturing shared
characteristics between countries such as common language, shared borders, free trade
agreements, colonial ties, or the use of a common currency. Owing to its strong
explanatory power and consistent empirical relevance, the gravity model has become the
standard analytical framework for evaluating the determinants of a country’s export

14
performance and for measuring the impact of trade policies in the context of international
economic integration. Moreover, the model has been widely applied in studies examining
the effects of trade liberalization, monetary unions, and foreign direct investment (FDI)
on trade (Frankel, 1997; Rose, 2000).
To analyze the determinants of trade flows, this study adopts the Gravity model of
International Trade. This theoretical framework was originally proposed by Tinbergen
(1962), drawing an analogy with Newton’s law of universal gravitation. It posits that
bilateral trade flows are directly proportional to the economic mass of the trading partners
and inversely proportional to the physical distance between them.
However, to better capture market size dynamics and specific trade facilitators,
this research employs the Augmented Gravity Model. Building upon the theoretical
extensions by Linnemann (1966), the model incorporates population size and specific
dummy variables. The general multiplicative form of the equation is expressed as
follows:
β β β β β β
𝑋𝑖𝑗 = β0𝑌𝑖 1𝑌𝑗 2𝐷𝑖𝑗3𝑁𝑖 4𝑁𝑗 5𝐴𝑖𝑗6

Where:
-​ 𝑋𝑖𝑗: The volume of exports from country i to country j.

-​ β0: The constant term.

-​ 𝑌𝑖, 𝑌𝑗: The GDPs of the exporting and importing countries, respectively.

-​ 𝑁𝑖, 𝑁𝑗: The population of the exporting and importing countries, respectively.

-​ 𝐷𝑖𝑗 : The geographical distance between the capitals of the two countries.

-​ 𝐴𝑖𝑗: A set of dummy variables capturing shared characteristics or preferential

relationships between country i and country j (e.g., common borders, shared

language, or trade agreements).

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1.3. Institutional economics - The role of political stability
Modern institutional economics emphasizes the role of institutions - including
laws, regulations, enforcement mechanisms, and social norms - as the foundational
structures that shape economic behavior and market performance. According to North
(1990), institutions function as the “rules of the game” governing economic interactions,
helping reduce transaction costs, uncertainty, and risks in exchange relationships.
High-quality institutions create a transparent economic environment, protect property
rights, and ensure contract enforcement, thereby strengthening investment incentives and
expanding trade.
In the context of international trade, transaction costs and risks associated with
institutional stability have a direct impact on trade activities. An effective institutional
system not only reduces compliance costs, contract-related costs, and logistics expenses,
but also enhances policy predictability, enabling firms to confidently expand production
and access foreign markets.
Building on this theoretical foundation, Acemoglu et al. (2001) demonstrate that
institutional quality is a key determinant of long-term economic outcomes. Countries
with stable and reliable institutional systems tend to attract more international
transactions due to lower risks and higher transparency. This implies that institutions
influence not only overall economic growth but also directly affect a nation’s ability to
engage in international trade, including export performance.
Synthesizing these two approaches, the Institutional Economics framework
highlights that:
-​ Strong institutions help lower transaction costs, which in turn expand production
and business activities, thereby enhancing the capacity for export supply.
-​ Stable institutions help reduce risk and uncertainty, thereby facilitating
international transactions and enabling firms to access foreign markets more
easily.

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 Institutional quality plays a central role in trade efficiency, influencing the
competitiveness of export products and determining the extent of a country’s integration
into the global economy.
Therefore, in research on export performance, Institutional Economics provides a
robust theoretical foundation for analyzing how institutional quality-through reducing
transaction costs, ensuring stability, and strengthening investor confidence-either
promotes or constrains a country’s export activities.
1.4. Value-added production theory
According to the U. S. Bureau of Economic Analysis (2006), the value added of
an industry - also referred to as gross domestic product (GDP) by industry - represents
the contribution of a private industry or government sector to overall GDP. The
components of value added include employee compensation, taxes on production and
imports (less subsidies), and gross operating surplus. Value added is calculated as the
difference between an industry’s gross output (including sales or receipts and other
operating income, commodity taxes, and inventory changes) and the cost of its
intermediate inputs (such as energy, raw materials, semi-finished goods, and purchased
services from all sources).
Chenery and Taylor (1968) argue that value added in production reflects the
degree of industrial development and the productive capacity of a country. Nations with
high value added tend to produce higher-quality goods and participate more deeply in
global value chains. Hausmann et al. (2005) further demonstrate that a country’s
production structure determines the types of goods it exports and the competitiveness of
its products in international markets. Therefore, manufacturing value added is considered
a key variable representing production capability and output quality, both of which have a
direct impact on export performance.
1.5. Definition and theoretical foundation of variables in the model
This study establishes an econometric regression model using panel data to
evaluate the impact of various macroeconomic and institutional factors on the total trade
value (TRADE_VAL) of Asia-Pacific countries. The selection of variables is based on a

17
synthesis of established international trade theories and empirical evidence concerning
national competitiveness

1.5.1. Dependent variable

The dependent variable in this study is Total Trade Value (TRADE_VAL), which
captures the overall scale of each country’s engagement in international trade. Following
the World Bank’s definition of trade as the sum of merchandise exports and imports,
TRADE_VAL is constructed by first aggregating exports and imports of goods, expressed
in current US dollars, and then converting this nominal value into real terms by dividing
it by the GDP deflator, thereby adjusting for changes in the general price level over time.
𝑀𝐸𝑖𝑡 + 𝑀𝐼𝑖𝑡
𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿𝑖𝑡 = 𝐷𝐺𝐷𝑃
𝑖𝑡

​ In which:
-​ 𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿𝑖𝑡: Total Trade Value of country i in year t.
-​ 𝑀𝐸𝑖𝑡 : Merchandise Exports of country i in year t.
-​ 𝑀𝐼𝑖𝑡 : Merchandise Imports of country i in year t.
-​ 𝐷𝐺𝐷𝑃 : GDP Deflator of country i in year t.
𝑖𝑡

To enhance coefficient interpretability in the regression analysis, the raw USD

values are converted into billion USD (as described in Section 2.1.2). This ratio serves as
a standard measure of a nation's economic openness and the scale of its international
trade activities, widely used by economists to assess the importance of trade to a country
(Grossman et al., 1991).

1.5.2. Explanatory variables

a. Purchasing Power Parity (PPP)

Purchasing Power Parity (PPP) is used as a core explanatory variable and is
measured using the Price Level Ratio (PLR), which the World Bank defines as “the ratio
of a purchasing power parity (PPP) conversion factor to the corresponding market

18
exchange rate” (World Bank, [Link], 2024). As specified in Section 1.3.1 of
this report, the Price Level Ratio is defined as:
𝑃𝑃𝑃 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑓𝑎𝑐𝑡𝑜𝑟 𝑓𝑜𝑟 𝐺𝐷𝑃
𝑃𝑟𝑖𝑐𝑒 𝐿𝑒𝑣𝑒𝑙 𝑅𝑎𝑡𝑖𝑜 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝐸𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑅𝑎𝑡𝑒
(𝑈𝑛𝑖𝑡𝑒𝑑 𝑆𝑡𝑎𝑡𝑒𝑠 = 1)
This measure indicates the relative domestic price level of each country compared
to the United States. The theoretical foundation of PPP in this study is derived from the
classical Purchasing Power Parity theory (Cassel, 1918) and the role of PPP in
determining the real exchange rate and international price competitiveness (Krugman et
al., 2018; Dornbusch, 1985), all of which were discussed earlier in Section 1.1.1. In the
empirical model, PPP is treated as a dimensionless variable. Theoretically, PPP plays a
crucial role in determining the real exchange rate (RER), thereby influencing the price
competitiveness of goods in the international market (Obstfeld & Rogoff, 2009).
b. Political Stability (STAB)
Political Stability (STAB) is an institutional control variable, quantified using the
Political Stability and Absence of Violence/Terrorism index from the World Bank’s
Worldwide Governance Indicators (WGI) (Kaufmann et al., 2010). The index ranges
from: -2.5 (low stability) to 2.5 (high stability). The stability of the political and
institutional environment has been proven to be a key factor in mitigating risk, increasing
transparency and policy predictability, thereby lowering commercial transaction costs and
attracting investment, which ultimately fosters international trade (Acemoglu et al.,
2004).
c. Trade In Services (TIS)
Trade In Services (TIS) is included in the model to reflect the role of the
trade-supporting service sector. This variable is measured as the total value of trade in
services as a percentage of GDP. TIS is measured as:
𝑇𝑟𝑎𝑑𝑒 𝑖𝑛 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠
𝑇𝐼𝑆𝑖𝑡= 𝐺𝐷𝑃𝑖𝑡
𝑖𝑡
× 100

Services such as transport, logistics, finance, and communication are considered

essential infrastructure elements that reduce geographical barriers and the cost of

19
cross-border trade operations. The development of TIS is expected to correlate positively
with TRADE_VAL by improving supply chain efficiency (Francois & Hoekman, 2010).
d. Manufacturing Value Added (MANU)
Manufacturing Value Added (MANU) measures the productive capacity and
industrial scale of an economy. According to the U.S. Bureau of Economic Analysis
(2006), manufacturing value added represents the contribution of the manufacturing
sector to GDP after subtracting intermediate inputs. In the dataset used for this study,
MANU is recorded in current US dollars and converted into billions USD during data
processing. Formally:
𝑀𝐴𝑁𝑈𝑖𝑡 = 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑉𝑎𝑙𝑢𝑒 𝐴𝑑𝑑𝑒𝑑 (𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑈𝑆$)
A strong manufacturing base is theoretically linked to greater participation in
global value chains and higher trade intensity, consistent with the arguments by Chenery
and Taylor (1968) and Hausmann et al. (2005) discussed earlier in Section 1.1.6.

2. Literature Review

2.1. International Literature Review

The relationship between relative Purchasing Power Parity (PPP) and trade flows
has been a central topic in international economics. The theory of Purchasing Power
Parity (PPP), formalized by Gustav Cassel (1918), is fundamental to this discourse.
Initially conceived as a theoretical condition in which prices equalize across borders, PPP
has evolved into a sophisticated tool for assessing national competitiveness.
Taylor and Taylor (2004) grounded their analysis of Purchasing Power Parity
(PPP) in the theoretical framework of the Law of One Price (LOOP). While positing that
arbitrage activities theoretically establish PPP as a long-run equilibrium, the authors
highlighted the persistence of significant short-term deviations which is a phenomenon
commonly referred to as the 'PPP Puzzle'. They identified trade barriers and transaction
costs as the primary factors preventing absolute price convergence. Consequently, this
misalignment between the real exchange rate and the PPP level becomes a critical driver

20
of trade patterns; specifically, a domestic currency that is undervalued relative to its
purchasing power confers a competitive price advantage, thereby stimulating the
expansion of total trade volume.
While the theoretical long-run equilibrium of PPP is well-established, empirical
modeling must account for the significant lag in price adjustments. Rogoff (1996), in his
seminal work, articulated the 'Purchasing Power Parity Puzzle,' which highlighted the
disconnect between the extreme short-term volatility of real exchange rates and the
remarkably slow rate at which these shocks damp out. He noted that while financial
shocks can cause rapid currency fluctuations, the consensus estimate for the half-life of
PPP deviations, which is the time required for a divergence to be reduced by half, is
typically between three to five years. This finding implies that international goods
markets are not seamlessly integrated in the short run due to nominal price rigidities and
transaction costs.
Providing a more contemporary policy perspective, Auboin et al. (2013)
conducted a comprehensive review for the World Trade Organization (WTO) regarding
the link between currency valuation and trade performance. Their synthesis of recent
empirical literature distinguishes clearly between exchange rate 'volatility' (short-term
fluctuations) and 'misalignment' (persistent deviation from equilibrium levels like PPP).
Crucially, Auboin and Ruta concluded that while short-term volatility often has a
negligible impact due to hedging instruments, persistent exchange rate misalignment can
significantly alter trade incentives. Specifically, they found evidence that undervaluation
serves as a subsidy to exports and a tax on imports, thereby structurally affecting the
Total Trade Value.
Complementing the theoretical discussion on price convergence, Rodrik (2008)
offered a compelling empirical perspective on the strategic role of exchange rate
valuation in economic performance. Moving beyond the standard Balassa-Samuelson
framework, Rodrik constructed an index of 'undervaluation' which is defined as the
deviation of the real exchange rate from its PPP implied level adjusted for per capita
income. His central argument is that maintaining a currency value that is competitive

21
(undervalued) relative to PPP acts as a potent subsidy for the tradable sector. Rodrik
posited that the tradable sector such as primarily manufacturing is 'special' because it
suffers disproportionately from market failures and institutional weaknesses compared to
non-tradables. Consequently, an undervalued exchange rate increases the profitability of
tradable activities, thereby stimulating structural change and expanding export capacities.
This mechanism is particularly relevant for the Asia-Pacific context, where export-led
growth strategies driven by competitive pricing and robust manufacturing sectors have
been historically prominent.
While Rodrik (2008) emphasized the positive nexus between undervaluation and
structural change, recent literature introduces a critical caveat regarding distributional
channels. Ribeiro et al. (2020) reassessed this relationship, arguing that the impact of real
exchange rate (RER) misalignment on the economy is characterized by two conflicting
effects. On the one hand, consistent with the inclusion of Manufacturing Value Added in
the current model, the article acknowledges that undervaluation promotes
growth-enhancing changes in the productive structure by stimulating technological
progress and boosting the industrial sector. On the other hand, it highlights that
undervaluation may raise income inequality by redistributing income from wages to
profits, which could depress aggregate consumption and offset the gains from trade.

2.2. Review of Research in Asia-Pacific

In the specific context of the Asia-Pacific region, the relationship between pricing
factors and trade values is heavily conditioned by the structure of production networks.
Thorbecke (2015) pointed out his analysis of regional trade flows, which highlighted the
dominance of fragmented supply chains (also known as Triangular Trade). He observed
that emerging Asian economies typically import capital goods and high-tech components
from advanced nations (like Japan and South Korea) to assemble and re-export final
products to global markets. This structural characteristic has profound implications for
the model. Thorbecke argued that the elasticity to exchange rate deviations (PPP) in this
region is complex. Specifically, while a depreciation (favorable PPP) enhances the

22
competitiveness of the value-added portion of exports, it simultaneously increases the
cost of imported intermediate inputs. Consequently, Thorbecke suggested that for
Asia-Pacific nations with high Manufacturing Value Added, the trade-boosting effect of a
favorable PPP might be dampened compared to economies with less reliance on imported
components.
Focusing on the Southeast Asian sub-region, a recent study by Murad and Hossain
(2018) provides compelling evidence regarding the validity of the Purchasing Power
Parity (PPP) hypothesis among the ten ASEAN member countries. Using a
comprehensive dataset spanning from 1973 to 2015, the authors addressed the
methodological limitations of previous studies by employing second generation panel
unit root tests (specifically the CIPS test by Pesaran, 2007) and error correction based
panel cointegration tests (Westerlund, 2007). Contrary to earlier findings that often
rejected PPP due to low statistical power, they found support for the relative PPP
hypothesis in the ASEAN region. Their results indicated that the relative changes in
exchange rates and price ratios are cointegrated in the long run, even when accounting for
cross-sectional dependence among these integrated economies.
Providing specific evidence from Thailand which is a key manufacturing hub in
the Asia-Pacific region, Reunrojung (2008) has reassessed the impact of real exchange
rate (RER) misalignment on economic performance. While traditional theories suggest
that undervaluation (a favorable PPP deviation) consistently boosts growth, this study
highlights a critical trade-off relevant to the Thai context. The findings confirm that for
an economy like Thailand, RER undervaluation promotes growth-enhancing changes in
the productive structure.
Adding to the empirical evidence from Southeast Asia, Widodo (2008)
investigated the determinants of trade flows within the ASEAN region, with a specific
focus on major economies like Indonesia. The findings reinforce the significance of price
competitiveness in the region. Widodo observed that deviations in the real exchange rate
(a proxy for PPP changes) have a substantial impact on trade balances, which confirm

23
that for ASEAN nations and maintaining a competitive currency valuation is a primary
engine for export growth.

2.3. Research Gap

Despite the extensive literature on Purchasing Power Parity (PPP) and trade
dynamics, significant gaps remain when applying these classical theories to the
contemporary Asia-Pacific context.
Regarding the temporal and contextual scope, seminal studies such as Rogoff
(1996) and Taylor and Taylor (2004) primarily relied on data prior to the 21st century.
While establishing a robust theoretical foundation, these works do not capture the
structural transformations of the global economy over the last two decades. Specifically,
they predate major exogenous shocks such as the Global Financial Crisis (2007-2008)
and the COVID-19 pandemic (2019-2022), which have fundamentally reshaped regional
supply chains, altered production structures, and forced Asia-Pacific nations to adopt
more flexible exchange rate regimes. Consequently, existing models may fail to reflect
the complexity of trade flows in this “new normal” economic environment.
Furthermore, the rapid advancement of technology and the servicification of
manufacturing in the Asia-Pacific region have introduced new determinants of trade that
older models largely overlooked. Therefore, this study aims to bridge these gaps by
employing a comprehensive and up-to-date dataset spanning the period 2002-2023. By
integrating modern structural factors including Manufacturing Value Added and Trade in
Services into the analysis, this research seeks to provide a reassessment of the impact of
Purchasing Power Parity on the Total Trade Value of Asia-Pacific countries, offering
valuable insights relevant to policymakers in the post-crisis era.

24
3. Research Hypothesis Development

3.1. The Impact of Purchasing Power Parity on Total Trade Value

​ In this study, purchasing power parity (PPP) is measured by the price level ratio
(PLR), defined as the ratio of the PPP conversion factor for GDP to the market exchange
rate (US = 1). Consistent with the Balassa–Samuelson model, this price level ratio is
predicted to be an increasing function of a country’s real income, so higher PLR values
are typically observed in richer and more productive economies (Asea & Corden, 1994).
Within the national accounts framework, GDP is an aggregate measure of production,
income and expenditure in the economy and is therefore equal to the total income
generated by resident producers (UNCTAD, 2022). At the same time, it can be expressed
on the expenditure side as the familiar identity GDP = C + I + G + (X−M), that is, the
sum of final consumption, investment, government spending and net exports (Bureau of
Economic Analysis, 2025). Since these measures refer to the same aggregate, a sustained
increase in aggregate real income will be reflected in a higher level of real GDP.
According to the gravity model of international trade, bilateral trade flows are positively
related to the economic size of trading partners, usually measured by their GDP.
Empirical estimates by Primorac and Kozina (2020) show that GDP has a positive and
statistically significant effect on trade flows in their gravity model, implying that higher
GDP is associated with higher levels of total trade value. Thus, we state the following
hypothesis:
H1: Purchasing Power Parity positively affects Total Trade Value

3.2. The Impact of other indicators on Total Trade Value

3.2.1. The Impact of Political Stability on Total Trade Value

In the macroeconomic literature, political instability is viewed as a major source of

policy uncertainty that distorts economic decisions. Alesina et al. (1996) argue that
unstable political environments weaken incentives to undertake long-term investment that
supports economic activity and international trade. Similarly, De Haan and Siermann

25
(1996) show that political instability is associated with capital loss, reduced domestic
investment, capital flight and brain drain, all of which undermine production capacity and
a country’s ability to participate in international trade. These arguments suggest that more
politically stable economies are better able to sustain investment, production and
cross-border transactions, and are therefore expected to exhibit higher levels of exports
and imports. Accordingly, we propose the following hypothesis:
H2a: Political Stability positively affects the Total Trade Value of Asia-Pacific
countries.

3.2.2. The Impact of Trade ín Services on Total Trade Value

Recent research highlights the central role of services trade in shaping countries’
overall trade performance and development outcomes (Francois & Hoekman, 2010;
Lennon, 2009). Francois and Hoekman (2010) emphasise that the performance of service
sectors, together with the associated services policies, is an important determinant of
trade volumes, the distributional effects of trade, and long-run economic growth and
development. In line with this view, Lennon (2009) provides empirical evidence that
higher levels of Trade in Services (TIS) are accompanied by substantial increases in trade
in goods, estimating that a 10% rise in services trade is associated with approximately a
4.6% rise in traded goods. Taken together, these findings imply that economies in which
Trade in Services (TIS), measured as a percentage of GDP, is higher are better positioned
to expand both the services and goods components of external transactions, and thus to
achieve a higher Total Trade Value (TRADE_VAL). In light of the above discussion, the
following hypothesis is formulated:
H2b: Trade in Services positively affects the Total Trade Value.

3.2.3. The Impact of Manufacturing Value Added on Total Trade Value

In the Asia–Pacific region, manufacturing is a key driver of international trade and

a central component of countries’ growth strategies. Seric and Tong (2019) show that
manufactured products have rapidly become the principal exports of East and South East

26
Asian economies. This evidence indicates that a higher level of manufacturing value
added is typically accompanied by greater volumes of manufactured exports. Empirical
evidence from emerging markets further supports this link, as Sankaran et al. (2021) use a
dynamic panel ARDL model and find that a 1% increase in manufacturing value added
leads to roughly a 0.26% increase in exports, suggesting that manufacturing output is
highly responsive to global demand. Since total trade value is defined as the sum of
exports and imports, and the expansion of manufacturing also requires greater imports of
intermediate inputs and capital goods, increases in manufacturing value added are
therefore expected to raise overall trade volumes. Hence, we propose the following
hypothesis:
H2c: Manufacturing Value Added positively affects Total Trade Value

On the basis of these hypotheses, we developed the research model presented in

Figure 1.x below, which summarises the proposed relationships between Purchasing
Power Parity (PPP), Political Stability (STAB), Trade in Services (TIS), Manufacturing
Value Added (MANU) and Total Trade Value (TRADE_VAL).

27
Figure 1.1: Research Model

(Source: Author, 2025)

28
 CHAPTER 2: RESEARCH METHODOLOGY AND ECONOMETRIC
MODEL

1. Research Methodology

1.1. Data Collection Methods

The data required for model estimation consists of secondary sources, which were
subsequently organized into a panel dataset. The sample includes 440 observations
collected from 2002 to 2023 across 20 Asia-Pacific countries, encompassing the
dependent variable, Total Trade Value, and four independent variables: Purchasing Power
Parity, Political Stability, Trade in Services, and Manufacturing Value Added. All data
was compiled and processed from the World Bank database.
​
1.2. Data Analysis Methods
Our research team employed a linear regression model using the Ordinary Least
Squares (OLS) estimation method and executed the model in STATA 17 to analyze
variations in the dependent variable with respect to the independent variables. Microsoft
Excel and Microsoft Word were also utilized to compile and process the data for the
completion of this paper.
To enhance the interpretability of the regression coefficients, the variables Total
Trade Value and Manufacturing Value Added, originally measured in USD, were
converted into units of billion USD.
Within the collected sample, the research variables contain instances of missing
data, as shown in Table…. The table reports the frequency and percentage of missing
values relative to the total number of observations.

No. Objective Method

1 Assessing multicollinearity issues Variance Inflation Factor (VIF) Test

2 Heteroskedasticity Test Breusch-Pagan Test

29
 3 Remedies for Heteroskedasticity The Driscoll-Kraay standard errors
estimator

4 Normality Test Skewness and Kurtosis Test

5 Testing the significance of regression P-value Test

coefficients and overall model fit

6 Autocorrelation Test Arellano-Bond Test

7 Remedies for Autocorrelation The Driscoll-Kraay standard errors

estimator
Table 2.1: Diagnostic Tests and Methods for Addressing Model Deficiencies

(Source: Author, 2025)

Variable Missing Total Percent Missing

MANU 7 440 1.59

TIS 3 440 0.68
TRADE_VAL 0 440 0.00
STAB 0 440 0.00
PPP 0 440 0.00

Table 2.2 The frequency and proportion of missing values for each variable

(Source: Author, 2025)

To ensure the completeness and continuity of the time series, the linear
interpolation method in Stata 17 was applied to estimate and impute the missing values.
Linear interpolation estimates unknown data points within the range of a discrete set of
known observations, under the assumption that the data points lie on a straight line,
meaning the change between two observations is linear. In this study, all variables are
continuous annual data, and the proportion of missing values for each variable does not
exceed 10% of the total number of observations. Therefore, the use of linear interpolation

30
preserves the sample size and maintains the stability of the dataset. Additionally, this
method does not distort the distribution of the variables, as the interpolation is performed
only within missing-value intervals of up to 5 consecutive years.

2. Building the Regression Model

2.1. Model Specification

Based on a review of previous domestic and international studies, combining with
group discussions and the process of collecting relevant data, this study proposes the
following independent variables that may affect the dependent variable, Total Trade
Value (TRADE_VAL): Purchasing Power Parity (PPP), Political Stability (STAB), Trade
in Services (TIS) and Manufacturing Value Added (MANU). The dataset was then
compiled and the model was estimated using the Stata software.

2.1.1. Population Regression Model

​ Following existing literatures, we constructed the population regression model as

below:
𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿𝑖 = β0 + β1 𝑃𝑃𝑃𝑖 + β2 𝑆𝑇𝐴𝐵𝑖 + β3 𝑇𝐼𝑆𝑖 + β4 𝑀𝐴𝑁𝑈𝑖 + 𝑢𝑖

In which:
-​ 𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿𝑖: Total Trade Value in country i at time t.

-​ 𝑃𝑃𝑃𝑖: Purchasing Power Parity in country i at time t.

-​ 𝑆𝑇𝐴𝐵𝑖 , 𝑇𝐼𝑆𝑖, 𝑀𝐴𝑁𝑈𝑖: Controlled Variables in country i at time t.

-​ β0: Intercept.

-​ β1 : Coefficient of the Purchasing Power Parity variable.

-​ β2: Coefficient of the Political Stability variable.

-​ β3: Coefficient of the Trade in Services variable.

31
 -​ β4: Coefficient of the Manufacturing Value Added variable.

-​ 𝑢𝑖: Error term.

2.1.2. Sample Regression Model

To quantify the impact of the independent variables on the dependent variable, we

estimate the following sample regression model:

𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿𝑖 = β0 + β1 𝑃𝑃𝑃𝑖 + β2𝑆𝑇𝐴𝐵𝑖 + β3 𝑇𝐼𝑆𝑖 + β4 𝑀𝐴𝑁𝑈𝑖 + 𝑢𝑖

In which:

-​ β0: Estimator of Intercept.

-​ β1: Estimator of coefficient of the Purchasing Power Parity variable.

-​ β2: Estimator of coefficient of the Political Stability variable.

-​ β3: Estimator of coefficient of the Trade in Services variable.

-​ β4: Estimator of coefficient of the ManufacturingValue Added variable.

-​ 𝑢𝑖: Estimator of Error Term.

2.2. Explanation of Variables, Units and Expected Impact on the Dependent Variable
​ Building on a solid theoretical foundation and insights from prior studies, we
specify a model in which TRADE_VAL is the dependent variable, PPP is the main
independent variable, and TIS, STAB, and MANU are included as control variables.

Variable
No. Variable Description Unit Data source
Type

Dependent Total Trade current

1 𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿 Worldbank
Variable Value US$

Independent 2 𝑃𝑃𝑃 Purchasing none Worldbank

32
Variable Power Parity

Political
3 𝑆𝑇𝐴𝐵 none Worldbank
Stability

Trade in
4 𝑇𝐼𝑆 % of GDP Worldbank
Service

Manufacturing current
5 MANU Worldbank
Value Added US$

Table 2.3: Explanation of Variables

(Source: Authors, 2025)

No. Coefficient Expected sign Hypothesis

H1: Purchasing Power

1 β1 + Parity positively affects Total
Trade Value

H2a: Political Stability

2 β2 + positively affects Total Trade
Value

H2b: Trade in Service

3 β3 + positively affects Total Trade
Value

H2c: Manufacturing Value

4 β4 + Added positively affects Total
Trade Value

Table 2.4: Expected signs of the regression coefficients

(Source: Authors, 2025)

33
3. Data Description

3.1. Data Sources

The analysis utilizes a balanced panel dataset comprising 440 observations
sourced from the World Bank’s World Development Indicators (WDI). The variables
include Purchasing Power Parity (PPP), Trade in Services (TIS), Total Trade Value
(TRADE_VAL), Political Stability (STAB), and Manufacturing Value Added (MANU).
The study covers the period from 2002 to 2023 across 20 distinct economies: Australia,
Brunei Darussalam, Cambodia, China, Fiji, Hong Kong (SAR China), Indonesia, Japan,
the Republic of Korea, Lao PDR, Macao (SAR China), Malaysia, Mongolia, New
Zealand, Papua New Guinea, the Philippines, Samoa, Singapore, Thailand, and Vietnam.

3.2. Descriptive Statistics

Descriptive statistics for the variables TRADE_VAL, PPP, STAB, TIS, and
MANU were calculated to provide an overview of the data characteristics. The results are
summarized in the table below:

Variable Obs Mean Std. dev. Min Max

TRADE_VAL 440 496.8555 924.7059 0.280347 5869.722

PPP 440 0.5525529 0.2747406 0.1396511 1.588137

STAB 440 0.3221073 0.8248715 -2.095395 1.599125

TIS 440 26.81582 25.18355 2.004511 135.4257

MANU 440 225.4956 665.4234 0.0343239 4909.021

Table 2.5: Descriptive Statistics of Variables (2002-2023)

(Source: Authors, 2025)
The table 2x presents the descriptive statistics for the variables included in the
model, specifically detailing the Number of Observations (Obs), Mean, Standard

34
Deviation (Std. Dev.), Minimum (Min), and Maximum (Max) values for each variable.
The specific results are as follows:
-​ Total Trade Value (TRADE_VAL): The mean value is approximately 496.86 %,
with a minimum of 0.28 % and a maximum of 5869.72 %. The substantial
standard deviation (924.71%) reflects a profound disparity in international trade
scales among the sampled economies, ranging from those with minimal trade
turnover to leading global trading powers.
-​ Purchasing Power Parity (PPP): This variable exhibits a mean of 0.55 %,
fluctuating between a low of 0.14 % and a high of 1.59 %. These figures indicate
relative differences in price levels and the actual purchasing power of currencies
across the nations in the Asia-Pacific region.
-​ Political Stability (STAB): The average index score is 0.32 %. Notably, this
variable demonstrates strong differentiation, ranging from negative values (-2.10
%) to positive values (1.60 %). This underscores a diverse political landscape,
encompassing both political environments and highly stable nations during the
study period.
-​ Trade in Services (TIS): The average rate stands at 26.82 %, with a minimum of
approximately 2.00 % and a maximum of 135.43 %. These statistics reveal
significant variation in the contribution of the service sector to total trade,
indicating that while some economies are highly dependent on service exports,
others are not.
-​ Manufacturing Value Added (MANU): The mean value is 225.50 %. Similar to
the trade variable, the extremely wide range between the minimum (0.03 %) and
maximum (4909.02 %) values evidences a sharp polarization in industrial
production capacity and economic development levels among the countries in the
sample.
3.3. Correlation Analysis
a)​ Correlation between the Independent Variable and Dependent Variables

35
 A pairwise correlation analysis was conducted to examine the linear relationships
among the study variables. The resulting correlation matrix is presented in the table
below:

Variable TRADE_VAL STAB PPP TIS MANU

TRADE_VAL 1.0000

STAB -0.0969 1.0000

PPP 0.2120 0.4968 1.0000

TIS -0.1424 0.3850 -0.0137 1.0000

MANU 0.9287 -0.1406 0.1526 -0.2462 1.0000

Table 2.6: Correlation Analysis among Variables

(Source: Authors, 2025)
-​ Relationship between TRADE_VAL and PPP: The pairwise correlation
coefficient between Total Trade Value (TRADE_VAL) and Purchasing Power
Parity (PPP) is r = 0.2120. This correlation is classified as a weak positive
relationship. The result suggests that as the Purchasing Power Parity of a country
increases, the Total Trade Value tends to rise. However, the linear effect is neither
substantially strong nor clearly pronounced.
-​ Relationship between TRADE_VAL and MANU: The correlation coefficient is
r = 0.9287. This represents an extremely strong positive correlation, approaching
unity. This finding reflects an exceptionally tight linkage, indicating that
Manufacturing Value Added (MANU) plays a decisive role and is strongly

36
 co-moving with the Total Trade Value (TRADE_VAL) of the countries in the
sample.
-​ Relationship between TRADE_VAL and TIS: The correlation coefficient is r =
-0.1424. This is a weak negative relationship, implying that as the share of Trade
in Services increases, the Total Trade Value tends to slightly decline (this may be
due to a structural shift or the characteristic of economies with a high proportion
of services trade but a small scale of merchandise trade).
-​ Relationship between TRADE_VAL and STAB: The correlation coefficient
between the two variables is only r = -0.0969. This result suggests that the level of
political stability exhibits virtually no clear linear relationship with the fluctuations
in total trade value during the study period.
b) Correlation among Independent Variables
The resulting correlation matrix indicates that the independent and control
variables exhibit correlations at moderate to low levels, specifically:
-​ The most notable relationship between the two explanatory variables are STAB
and PPP, and has a coefficient of r = 0.4968. This moderate positive correlation
suggests that countries with a more stable political environment are often
associated with a higher level of purchasing power parity.
-​ The STAB variable also shows a moderate positive correlation with TIS (r =
0.3850), which reflects a tendency for more stable countries to have a higher
proportion of trade in services.
-​ Most importantly, the correlation coefficient between PPP and the variable with
the strongest influence (MANU) is only at a low level at r = 0.1526. This is a
positive sign for the regression model, indicating that these two significant
explanatory variables provide relatively independent information. Thereby
mitigating concerns about severe multicollinearity that could potentially bias the
estimated coefficient for the PPP variable.

37
 CHAPTER 3: ESTIMATION, MODEL TESTING AND STATISTICAL
INFERENCE

1. OLS Regression Result

The estimation results of the OLS regression model using Stata are reported as
follows:

Variables IUR

337.0284***
PPP
(69.05873)

-65.36283***
STAB
(24.6551)

4.076732***
TIS
(0.6999266)

1.295963***
MANU
(0.0247134)

-69.8714
Intercept
(44.05231)

Number of Observations 440

Coefficient of Determination R2 0.8772

F Statistics: F(4, 435) 776.64

F Probability (Prob > F) 0.0000

Root Mean Squared Error (Root MSE) 325.57

38
 Robust standard errors are reported in parentheses. ***p<0.01,**p<0.05,*p<0.1

Table 3.1: OLS Regression Result

(Source: Authors, 2025)
1.1. Interpretation of Regression Coefficients
Among the independent variables, Purchasing Power Parity (PPP, measured by the
Price Level Ratio) is the key explanatory factor of interest. The regression result shows a
positive coefficient (β = 337.0284, p < 0.001), indicating that, holding Political Stability
(STAB), Trade in Services (TIS), and Manufacturing Value Added (MANU) constant, a
one-unit in the Purchasing Power Parity (PPP) indicator is associated with an increase of
approximately 337 billion USD in Total Trade Value (TRADE_VAL).
The variable Political Stability (STAB) carries a negative coefficient (β =
-65.36283, p = 0.008). This suggests that, holding Purchasing Power Parity (PPP), Trade
in Services (TIS), and Manufacturing Value Added (MANU) constant, an increase in the
Political Stability index is associated with a decline in Total Trade Value (TRADE_VAL).
This result runs counter to the usual expectation that a more stable political environment
promotes trade, and may reflect specific features of the Asia-Pacific sample or potential
multicollinearity with other development variables. Therefore, it should be interpreted
with caution rather than as a clear causal effect.
Both Trade in Services (TIS) and Manufacturing Value Added (MANU) have
positive coefficients (β = 4.076732 and β = 1.295963, respectively; p < 0.001 in both
cases). Empirically, this means that increases in Trade in Services (TIS) and
Manufacturing Value Added (MANU) output are associated with higher Total Trade
Value (TRADE_VALUE), all else equal. These results underline the complementary roles
of the services sector and manufacturing activity in driving trade performance in the
Asia-Pacific region.
The constant term (_cons) is negative (β = -69.8714), representing the predicted
trade value when all regressors are set to zero, a situation that is not economically
meaningful in this context.

39
1.2. Coefficient of determination R2
The coefficient of determination R2 = 0.8772 indicates that the independent
variables which are Purchasing Power Parity (PPP, measured by the price level ratio),
Political Stability (STAB), Trade in Services (TIS), and Manufacturing Value Added
(MANU) jointly explain about 87.72% of the variation in the dependent variable, namely
Total Trade Value (TRADE_VAL). The remaining 12.28% of the variation in Total Trade
Value (TRADE_VAL) is attributed to other factors not included in the model.
At the 5% significance level, all independent variables have p-values less than
0.05. Therefore, the independent variables in the model are statistically significant in
explaining changes in Total Trade Value (TRADE_VAL).

2. Model Defect Test

To ensure the reliability of the Ordinary Least Squares (OLS) estimation,

diagnostic tests were conducted to detect potential model defects, including
multicollinearity, heteroskedasticity, and autocorrelation. Based on the regression results,
the estimated model is specified as follows:

𝑇𝑅𝐴𝐷𝐸_𝑉𝐴𝐿𝑖 = − 69. 8714 − 65. 36283𝑆𝑇𝐴𝐵𝑖 + 337. 0284𝑃𝑃𝑃𝑖 + 4. 076732𝑇𝐼𝑆𝑖

+ 1. 295963𝑀𝐴𝑁𝑈𝑖
2.1. Multicollinearity Test
Multicollinearity arises when there is a high degree of correlation among
independent variables within the model. This phenomenon results in instability in the
regression coefficient estimates and inflated standard errors, which consequently
compromises the reliability of statistical significance tests for individual predictors.
Following the estimation of the OLS regression model for the proposed variables,
the Variance Inflation Factor (VIF) test was conducted to diagnose potential
multicollinearity issues. The calculated VIF results are presented in the table below:

40
 Variable VIF 1/VIF

STAB 1.71 0.583747

PPP 1.49 0.670700

TIS 1.29 0.777092

MANU 1.12 0.892789

Mean VIF 1.40

Table 3.2: VIF Test Results

(Source: Authors, 2025)
Regarding the correlation analysis, the Variance Inflation Factor (VIF) test was
conducted to rigorously detect multicollinearity among independent variables. As
presented in Table 3.2, the VIF values for the regression model range from 1.12 to 1.71,
with a mean VIF of 1.40. These figures are well below the generally accepted threshold
of 10, indicating that while multicollinearity technically exists, it is negligible and does
not pose a serious concern for the model's reliability. Therefore, the model is considered
free from severe multicollinearity defects.

2.2. Autocorrelation Test

In panel data regression models, aside from multicollinearity, autocorrelation (also
known as serial correlation) is frequently encountered. Autocorrelation occurs when the
error terms of the model in the current period are correlated with those in previous
periods. While its presence does not bias the coefficient estimates, it results in incorrect

41
standard errors, thereby affecting the reliability of statistical significance tests for the
variables.
To detect this phenomenon, following the OLS regression, the authors employed
the Arellano-Bond test with the following hypotheses:

This test is specifically designed to detect serial correlation in panel data. We

conducted the test in Stata 17 to examine autocorrelation up to order 14. Subsequently,
the P-value approach was used to compare the P-value against the significance level 𝛼.
-​ If P-value < 0.05: Reject the null hypothesis H0, indicating that
autocorrelation is present in the model.
-​ If P-value ≥ 0.05: Fail to reject the null hypothesis H0, concluding that there
is insufficient evidence of autocorrelation in the model.
To detect potential serial correlation, the dataset was first declared as a panel
structure. Subsequently, the Arellano-Bond test was conducted to examine
autocorrelation up to the 14th lag order. The detailed test results are presented below:

Lag Order (AR) z-statistic p-value

AR(1) 19.98 0.0000

AR(2) 18.93 0.0000

AR(3) 17.92 0.0000

42
AR(4) 16.77 0.0000

AR(5) 15.48 0.0000

AR(6) 14.16 0.0000

AR(7) 12.78 0.0000

AR(8) 11.24 0.0000

AR(9) 9.38 0.0000

AR(10) 7.53 0.0000

AR(11) 5.76 0.0000

AR(12) 4.16 0.0000

AR(13) 2.83 0.0047

AR(14) 2.14 0.0322

Table 3.3: Arellano-Bond Test for Autocorrelation

(Source:Authors, 2025)
The Arellano-Bond test results reveal that the test statistics for orders 1 through 14
are statistically significant, with P-values strictly below the 5% threshold. This
necessitates the rejection of the null hypothesis across the majority of test orders,

43
confirming the presence of high-order autocorrelation in the initial regression model and
suggesting substantial serial dependence in the error terms over time.
The presence of such pervasive autocorrelation renders OLS estimators inefficient,
although they remain unbiased. Specifically, the variance is not minimized, which
compromises the reliability of the F-test for overall significance. Consequently, relying
on the original OLS model would introduce potential biases in inference, thereby risking
the validity of any subsequent policy recommendations.
To ensure robustness and address the identified model defects, this study
implements the fixed-effects estimator with Driscoll-Kraay standard errors. This
estimation method is particularly effective as it enables the simultaneous correction of
heteroskedasticity, serial correlation, and cross-sectional dependence, thereby resolving
the diagnostic issues that were detected. Furthermore, since the regression model does not
include lagged dependent variables, this command provides consistent estimates with
robust inference. Consequently, it serves as a reliable alternative specification to validate
and confirm the empirical results.
The regression model was re-estimated using the Driscoll-Kraay estimator for the
dependent variable TRADE_VAL and the independent variables STAB, PPP, TIS, and
MANU. The adjusted regression results are presented in the table below:

Variables IUR

337.0284***
PPP
(99.39857)

-65.36283***
STAB
(19.38325)

4.076732***
TIS
(0.4661943)

44
 1.295963***
MANU
(0.0786503)

-69.8714*
Intercept
(49.04249)

Number of Observations 440

Number of Groups 21

Coefficient of Determination R2 0.8772

F Statistics: F(4, 21) 2828.63

F Probability (Prob > F) 0.0000

Root Mean Squared Error (Root MSE) 325.5651

Robust standard errors are reported in parentheses. ***p<0.01,**p<0.05,*p<0.1

Table 3.4.: Regression with Driscoll-Kraay Standard Errors

(Source: Authors, 2025)
Compared to the original OLS regression outcome, the adjusted regression results
with Driscoll-Kraay standard errors exhibit discernible differences in statistical reliability,
while the coefficient magnitudes remain unchanged.
Firstly, regarding overall model fit, the F-statistic witnessed a substantial increase
from F(4, 435) = 776.64 in the initial OLS model to F(4, 21) = 2828.63 in the
post-correction model. In either case, however, the probability (Prob > F) remains at
0.0000, suggesting that the model as a whole is statistically significant. Secondly, there
are distinct changes in the standard errors of the explanatory variables, reflecting the
necessary adjustments for autocorrelation and heteroskedasticity. Specifically, standard
errors decreased for the coefficients of STAB (from 24.6551 to 19.383) and TIS (from
0.6999266 to 0.4661943), whereas increases in standard errors were observed for PPP

45
(from 69.05873 to 99.39857) and MANU (from 0.0247134 to 0.0786503). These
adjustments ensure that the inference is more conservative and reliable. Thirdly,
regarding individual significance, the regression model reveals fortified p-values after
correction, all variables are still lower than 0.05, highlighting that all variables are still
significant at 5% significance level.
In summary, the application of regression analysis with Driscoll-Kraay standard
errors enabled the research team to eliminate autocorrelation from the model, thereby
mitigating potential defects.

2.3. Heteroskedasticity Test

A critical postulate of OLS regression is the constancy of error variance. The
violation of this assumption, referred to as heteroskedasticity, renders OLS estimators
inefficient, even though they remain unbiased. This inefficiency compromises the validity
of standard errors and statistical tests, making forecasts and inferences unreliable. To
investigate the presence of heteroskedasticity, this study employed a visual inspection of
the residuals through two distinct graphical methods.
To visually inspect the assumption of homoskedasticity, the research team plotted
the residuals against the fitted values derived from the OLS regression. This diagnostic
graph aids in detecting potential systematic patterns within the error terms, which would
indicate the presence of heteroskedasticity.

46
 Figure 3.1: The Plot of Residuals against Fitted Values
(Source: Authors, 2025)
Figure 3.1 depicts the Residuals vs. Fitted Values plot. As observed, the data
points are not randomly distributed around the zero reference line (y=0). Instead, the
residuals exhibit a tendency to spread wider as the fitted values increase, forming a
distinct funnel-shaped pattern. This visual evidence strongly suggests the existence of
heteroskedasticity in the regression model.
Based on this visual illustration, it can be preliminarily inferred that the model
likely suffers from heteroskedasticity and non-normality. However, graphical inspection
serves only as a qualitative assessment. Therefore, to rigorously validate the presence of
heteroskedasticity, the authors employed the Breusch-Pagan test with the following
hypotheses:

47
 This test is employed to assess whether the variance of the error terms in the
model remains constant. The test was conducted using Stata 17 software, utilizing the
P-value approach, which involves comparing the Prob > Chi-square value (the P-value)
against the significance level α
-​ If P-value < 0.05: The null hypothesis 𝐻0 is rejected, leading to the

conclusion that heteroskedasticity is present in the model.

-​ If P-value ≥ 0.05: There is insufficient evidence to reject 𝐻0 ,concluding

that there is no evidence of heteroskedasticity.

To examine the assumption of constant error variance, the Breusch-Pagan test for
heteroskedasticity was applied following the initial regression estimation. The diagnostic
results yielded a Chi-square test statistic of 141.38 with a P-value of 0.0000. Since this
P-value is strictly less than the significance level of 0.05 (and even 0.01), the null
hypothesis of constant variance is rejected. This indicates that heteroskedasticity is
present in the model, meaning the variance of the error terms is not constant across
observations.
Upon detecting heteroskedasticity in the regression model, the subsequent step is
to implement remedial measures to address this defect. To mitigate this issue, the authors
employed the Driscoll-Kraay standard errors estimator. This approach is superior to
robust standard errors as it simultaneously corrects for heteroskedasticity, serial
correlation, and cross-sectional dependence, thereby ensuring more reliable F-statistics
and t-statistics. The estimation results obtained from this method have been presented in
Table 3.4. Above.

2.4. Normality Test

A fundamental postulate of the Classical Linear Regression Model (CLRM) is the
normality of the error term distribution. The violation of this assumption, while not
affecting the unbiasedness of the OLS estimators, compromises the exact validity of

48
statistical inference procedures. Specifically, in the absence of normality, the t-statistics
and F-statistics may not follow their theoretical distributions, rendering hypothesis testing
and confidence intervals unreliable, particularly in finite samples.
To rigorously investigate the validity of this assumption, this study employed a
dual-diagnostic approach, combining a formal statistical test with a visual inspection of
the residuals through the Normal Q-Q Plot.

Figure 3.2: Normal Q-Q Plot of the Regression Residuals

(Source: Authors, 2025)
Figure 3.2. presents the Normal Q-Q plot, constructed by mapping the quantiles of
the estimated residuals against the quantiles of the theoretical normal distribution. This
graphical representation serves to visually assess the normality assumption of the error
terms. As observed, the data points generally align with the reference diagonal line in the
central region of the distribution. However, significant deviations are evident at both the

49
upper and lower tails, where the residuals diverge from the reference line, exhibiting a
distinct "heavy-tailed" pattern, indicating that the residuals do not strictly adhere to a
Gaussian distribution.
However, graphical inspection provides only a qualitative assessment. To
rigorously validate the presence of heteroskedasticity, the Skewness and Kurtosis test was
employed with the following hypotheses:

This test is employed to assess whether the error terms in the regression model
follow a normal distribution. The assessment was conducted using Stata 17 software,
utilizing the P-value approach, which involves comparing the Prob > Chi-square value
(the P-value) against the significance level α (typically 0.05).
-​ If P-value < 0.05: The null hypothesis 𝐻0 is rejected, leading to the

conclusion that the residuals do not follow a normal distribution.

-​ If P-value ≥ 0.05: There is insufficient evidence to reject 𝐻0, allowing for

the assumption that the residuals are normally distributed.

The diagnostic results presented an Adjusted Chi-square statistic of 126.42 with a
corresponding P-value of 0.0000. Given that the P-value is strictly lower than the
significance level of 0.05, the null hypothesis is rejected, implying that the residuals are
not normally distributed.
However, it is worth noting that the sample size is relatively large (440
observations). According to the Central Limit Theorem (CLT), the assumption of
normality can be relaxed in large samples, as the sampling distribution of the estimators
tends to be asymptotically normal. Therefore, the statistical inference (t-tests and F-test)
remains valid despite the violation of the normality assumption.

50
2.5. Conclusion
The diagnostic tests reveal that there is no evidence of multicollinearity in the
regression model, as the Mean VIF is only 1.40, well below the threshold. However,
subsequent tests highlight certain misspecification issues. Specifically, the Skewness and
Kurtosis test rejects the assumption of normal distribution. Furthermore, the
Breusch-Pagan test confirms the presence of heteroskedasticity, and the Arellano-Bond
test indicates the persistence of significant serial correlation in the residuals.

To mitigate these limitations, the study relies on two key justifications. First,
regarding the non-normality of residuals, the large sample size allows for the invocation
of the Central Limit Theorem, ensuring that statistical inference remains valid. Second, to
address heteroskedasticity and serial correlation, the model employs the estimator with
Driscoll-Kraay standard errors. This method offers robust inference that simultaneously
adjusts for heteroskedasticity, autocorrelation, and cross-sectional dependence.
Consequently, the estimated relationships between TRADE_VAL and the independent
variables (STAB, PPP, TIS, MANU) can be considered consistent and reliable under
these adjusted assumptions.

3. Hypothesis Testing

To ensure the reliability and robustness of the research findings after addressing
the identified model defects (specifically heteroskedasticity and autocorrelation), the
authors proceed to test the overall goodness of fit of the regression model and the
hypotheses regarding the regression coefficients. The subsequent analyses are based on
the estimation results obtained using the Driscoll-Kraay standard errors method (as
presented in the table above) to ensure the highest validity for statistical inferences. The
specific testing procedures and results are detailed as follows:

51
3.1. Test for Model Overall Significance
In linear regression analysis, the F-test is utilized to assess the overall goodness of
fit of the model by comparing the proportion of the explained variation (ESS) to the
unexplained variation (RSS) relative to the total variation (TSS). This relationship is
expressed by the equation:
𝐸𝑆𝑆 𝑅𝑆𝑆
1= 𝑇𝑆𝑆
+ 𝑇𝑆𝑆

Where:
-​ TSS (Total Sum of Squares): The total variation of the dependent variable.
-​ ESS (Explained Sum of Squares): The variation explained by the
independent variables.
-​ RSS (Residual Sum of Squares): The variation that remains unexplained
(error terms).
2 𝐸𝑆𝑆
The coefficient of determination, 𝑅 = 𝑇𝑆𝑆
, indicates the explanatory power of
2
the model. A higher 𝑅 suggests that the model better explains the dependent variable.
Consequently, testing the overall significance of the model is equivalent to testing
2
whether 𝑅 is significantly different from zero. The hypotheses are formulated as follows:

Based on the estimation results using the Driscoll-Kraay method (as presented in
table 3.4.), the authors test the null hypothesis using the F-statistic and the corresponding
P-value (Prob > F). The decision rule is applied as follows:
-​ If P-value < 0.05: Reject 𝐻0and accept 𝐻1, concluding that the model is

statistically significant.
-​ If P-value ≥ 0.05: Fail to reject 𝐻0 , concluding that the model is not

suitable.

52
 The regression output reveals an F-statistic of F(4, 21) = 2828.63 with a
probability value of Prob > F = 0.0000. Since the P-value = 0.0000 < 0.05, there is
sufficient statistical evidence to reject the null hypothesis 𝐻0and accept the alternative

hypothesis 𝐻1 at the 5% significance [Link], the coefficient of determination

2
𝑅 = 0.8772 indicates that the model explains approximately 87.72% of the variation in
the dependent variable.
The proposed regression model is deemed suitable and possesses high statistical
significance. This confirms that the variations in the independent variables, namely
STAB, PPP, TIS, and MANU, have a significant explanatory impact on the dependent
variable, Total Trade Value (TRADE_VAL)

3.2. Hypothesis Testing for Regression Coefficients

Having established the overall goodness of fit of the regression model, the
subsequent step is to rigorously examine the individual contribution and the direction of
impact of each independent variable on the dependent variable (Total Trade Value). To
this end, the study performs significance tests on the regression coefficients β𝑗 utilizing

the robust estimates obtained from the Driscoll-Kraay estimator. The application of
Driscoll-Kraay standard errors ensures that the t-statistics and associated P-values remain
valid and reliable, effectively mitigating the influence of prior model misspecifications.
For each explanatory variable, the general statistical hypotheses are formulated as
follows:

The decision to reject the null hypothesis 𝐻0is based on comparing the calculated

P-value against standard significance levels (α = 0.01, 0.05, 0.1). The detailed testing
results for each specific research hypothesis are analyzed below.

53
3.2.1. Test for H1: Purchasing Power Parity positively affects Total Trade Value

The study hypothesizes that an increase in purchasing power parity enhances trade
performance. The statistical hypotheses are:

Based on the regression results after employing the Driscoll-Kraay standard errors:
β1= 337.0284, t-value = 3.39, p-value = 0.003 < 0.01, indicating statistical significance at

the 1% level. Furthermore, the coefficient is positive, signaling that when Purchasing
Power Parity increases by 1 unit, the Total Trade Value increases by approximately
337.0284 billion USD, holding other factors constant. This outcome is entirely consistent
with the authors' initial expectations, where PPP was predicted to act as a catalyst for
trade performance. Consequently, the null hypothesis 𝐻0 is rejected, and the alternative

hypothesis 𝐻1 is supported.

3.2.2. Test for H2a: Political Stability positively affects Total Trade Value

Set up the null and alternative hypothesis:

According to the regression results, the estimated coefficient β₂ is -65.36283, with

a t-value of -3.37 and a p-value of 0.003 < 0.01, indicating statistical significance at the
1% level. However, the coefficient is negative, which stands in contrast to the authors’
initial expectation, suggesting that a one-unit increase in the Political Stability index is
associated with a decrease in Total Trade Value by approximately 65.36283 billion USD.
In other words, within the specific context of this sample, factors associated with
instability might correlate with higher trade volumes. Consequently, 𝐻2𝑎is strongly

rejected, and 𝐻0is supported.

54
3.2.3. Test for H2b: Trade in Service positively affects Total Trade Value

Set up the null and alternative hypothesis:

According to the regression results, the estimated coefficient β3is 4.076732, with

a t-value of 8.74 and a p-value of 0.000 < 0.01, indicating statistical significance at the
1% level. Moreover, the coefficient is positive, which is in complete agreement with the
authors' expectation, suggesting that for every 1 billion USD increase in Trade in
Services, the Total Trade Value increases by approximately 4.076732 billion USD,
holding other variables constant. This empirical finding highlights the crucial role of the
service sector in boosting overall trade performance. Consequently, the null hypothesis
𝐻0 is rejected, and the alternative hypothesis 𝐻2𝑎is accepted.

[Link]. Test for H2c: Manufacturing Value Added positively affects Total Trade Value
Set up the null and alternative hypothesis:

According to the regression results, the estimated coefficient β4 is 1.295963, with

a t-value of 16.48 and a p-value of 0.000 < 0.01, indicating statistical significance at the
1% level. The positive coefficient signals that when the manufacturing sector's value
added (as a percentage of GDP) increases by 1%, the Total Trade Value increases by
approximately 1.296 billion USD, holding other factors constant. This result is fully
consistent with the authors' expectation, confirming that the expansion of the
manufacturing sector serves as a vital driver for trade growth. Therefore, 𝐻0 is strongly

rejected, and 𝐻2𝑐 is supported.

55
4. Research Discussion

Based on the empirical findings obtained, the authors offer several overarching
observations as follows:
The Total Trade Value (TRADE_VAL), along with the variables PPP,
Manufacturing Value Added (MANU), Trade In Services (TIS), and Political Stability
(STAB), explains a substantial portion of the variation in trade among APAC countries
during the period 2002-2023. Specifically, the model’s coefficient of determination (R² =
0.8772) indicates that these variables jointly account for approximately 87.72% of the
fluctuations in Total Trade Value. The estimation results show that most independent
variables align with the research team’s initial expectations, except for STAB, which
exhibits a negative sign, an unexpected outcome that warrants deeper analysis,
particularly within the regional context.
First, Purchasing Power Parity (PPP) exerts a positive effect on Total Trade
Value (TRADE_VAL).
The regression results show that PPP has a positive and statistically significant
impact on TRADE_VAL, with a coefficient of β1 = 337.0284, indicating that a one-unit

increase in PPP is associated with an increase of approximately 337.03 billion USD in

total trade value. This empirical evidence strongly supports findings from theoretical and
empirical studies on the influence of relative prices on international trade (Krugman et
al., 2018; Dornbusch, 1985). When domestic prices are lower relative to international
prices, a country’s goods become more competitive, thereby boosting exports and
expanding the scale of trade transactions. Additionally, favorable relative prices enhance
the economy’s attractiveness to foreign investors, facilitating production expansion,
strengthening supply capacity, and ultimately promoting both imports and exports.
In the specific context of the Asia-Pacific region, where production costs are
generally lower than in developed economies, PPP plays a crucial role in sustaining
price-based competitive advantages. Countries such as Vietnam, Indonesia, and the
Philippines have leveraged relatively low price levels to foster the growth of

56
export-oriented manufacturing industries. Therefore, the positive effect of PPP is entirely
consistent with the region’s economic conditions.
Second, manufacturing value added (MANU) and trade in services (TIS) both
exert positive impacts on (TRADE_VAL).
In the model, both MANU and TIS carry positive and statistically significant
coefficients, with MANU exhibiting a coefficient of β4 = 1.295963 and TIS showing a

coefficient of β3= 4.076732, indicating that industrial production capacity and the degree

of service sector development play essential roles in promoting trade.

This finding is supported by international trade theory (Grossman & Helpman,
1991), which posits that the expansion of manufacturing increases exports of finished
goods as well as imports of intermediate inputs, thereby raising total trade. The APAC
region is a core hub of global supply chains, especially in electronics, components,
textiles, and machinery, so the increase in manufacturing value added naturally leads to
an expansion in trade.
Similarly, the development of service trade including logistics, finance,
information technology, tourism, and transportation-helps reduce transaction costs,
enhance supply chain efficiency, and facilitate import-export activities. Thus, the positive
effect of TIS on (TRADE_VAL) accurately reflects the role of services in the modern
trade structure of APAC economies.
Third, the regression results indicate that political stability (STAB) has a
negative effect on total trade value.
Theoretically, a stable political environment is expected to support trade by
lowering risks, improving policy predictability, and strengthening investor confidence.
However, in the case of APAC countries, the negative coefficient of STAB suggests
otherwise. The authors believe this unexpected phenomenon may be explained by three
key factors rooted in the structural and policy diversity of the APAC region:
a.​ Mismatch between Political Stability (STAB) and Trade Openness Orientation

57
 The negative coefficient suggests that high political stability does not necessarily
align with a strong trade openness orientation or a resulting trade boom in the APAC
region. This is driven by contrasting policy directions among country groups. On the one
hand, countries with high political stability and mature economies (such as Japan,
Australia, and New Zealand) often prioritize domestic market development or pursue
limited protectionist policies in certain sectors. These economies no longer experience
strong growth in merchandise trade compared to developing economies. This means high
STAB levels do not necessarily correspond to increased trade. Furthermore, some
politically stable countries may implement trade barriers, stringent standards, or
self-sufficiency-oriented strategies, which restrict international trade. On the other hand,
many developing economies with relatively lower STAB scores (as measured by the WGI
index)-specifically countries such as Vietnam, Indonesia, and the Philippines-exhibit
highly dynamic trade performance. These governments actively pursue aggressive trade
liberalization, attract large inflows of FDI, and sign numerous Free Trade Agreements
(FTAs). This strategic focus on openness and cost advantages allows them to participate
deeply in regional supply chains, resulting in strong trade growth despite moderate
political stability.
b.​ Discrepancy between STAB and the quality of “trade institutions”
The STAB index is primarily based on perceptions of political risk (e.g., coups,
terrorism, and political violence) and may not fully capture the quality of institutions that
directly facilitate trade, such as market openness, the quality of trade institutions, or FDI
attraction policies. This creates a functional discrepancy. In some cases, politically stable
countries maintain high STAB yet may lag in implementing reforms to enhance the
quality of “trade institutions”. such as efficient customs procedures, modern logistics
infrastructure, or streamlined trade standards. High political stability, therefore, fails to
translate into lower transaction costs for trade. Conversely, countries with moderate
STAB scores are often those actively reforming and strengthening their trade institutions
to attract investment and commerce. The model might be capturing the superior
trade-boosting effect of effective trade institutions over the mere presence of high

58
political stability alone. This may lead to discrepancies between theoretical expectations
and empirical results.
c.​ Potential Reverse Causality: Rapid Trade Growth Increases Perceived Political
Risk
A third explanation considers the possibility of reverse causality, where the very
act of rapid, large-scale trade expansion contributes to an increase in perceived political
risk, thereby reducing the measured STAB score. Fast globalization and trade growth can
intensify competition and create conflicts of interest among domestic economic groups
(e.g., between import-competing industries and export-oriented ones). Furthermore, rapid
economic transformation can lead to social unrest or heightened policy debates
(regarding labor laws, income inequality, or environmental standards). These internal
pressures and conflicts can be perceived by external assessors (who compile the WGI's
STAB) as signs of increased social and political volatility, even when the foundational
government stability remains intact. Thus, the negative coefficient may reflect that rapid
trade expansion is a source of relative instability in the APAC region, rather than
instability being the cause of restricted trade. This offers a new perspective to understand
the unexpected sign of the STAB coefficient.
In conclusion, the findings indicate that variables such as PPP, MANU, and TIS
positively influence total trade value consistent with theoretical expectations and the
development characteristics of the APAC region. The negative sign of STAB reflects
structural, policy-related, and openness-related differences among countries in the region.
This also suggests that future research could consider country grouping or incorporate
interaction terms to clarify this complex relationship. These findings not only reinforce
existing empirical evidence on international trade but also provide important implications
for policymakers in shaping economic and trade environments suited to each country’s
conditions and development objectives.

59
 CHAPTER 4: RECOMMENDATIONS AND IMPLICATIONS

1. Maintaining Competitive Pricing through Macroeconomic Stability

Based on the empirical results obtained from the regression model, particularly the
significant effects of Purchasing Power Parity (PPP), Manufacturing Value Added
(MANU), Trade In Services (TIS), and the Political Stability (STAB), this study proposes
several recommendations to promote trade growth among Asia-Pacific economies. These
recommendations are especially relevant for Vietnam, an economy that is deeply
integrated into regional value chains and oriented toward export-led growth.
First, the findings indicate that PPP exerts a positive influence on total trade value,
demonstrating the critical importance of maintaining stable and competitive domestic
prices. For Vietnam, this is particularly meaningful as the economy continues to face
inflationary pressures arising from fluctuations in global energy prices, fuel markets, and
exchange rates. Therefore, Vietnam should continue to pursue macroeconomic stability
through flexible monetary and fiscal policies, ensuring that inflation remains at a
manageable level in order to sustain the competitiveness of its export goods. At the same
time, to strengthen its position within regional supply chains, Vietnam should enhance
productivity and reduce production costs through technological innovation and process
optimization rather than relying solely on exchange-rate adjustments. Maintaining an
exchange rate for the Vietnamese dong that is aligned with international market
conditions is also essential for enabling Vietnamese exporters to formulate long-term
business plans and limit risks associated with price volatility.

2. Deepening the Manufacturing Sector and Value Chain Participation

Second, the empirical results reaffirm the pivotal role of the manufacturing sector
in driving trade value. This is also the sector that has consistently contributed the largest
share of Vietnam’s export revenue. However, Vietnam’s industrial structure still relies
heavily on the FDI sector and low value-added processing activities. Thus, Vietnam

60
should continue to promote the development of supporting industries, increase the
domestic content ratio, and invest in high-technology sectors such as electronics, smart
devices, and automation. Attracting FDI projects with the potential to generate
technological spillovers and establish linkages with domestic firms will help strengthen
Vietnam’s internal production capacity. Concurrently, the government should enable
Vietnamese enterprises to upgrade their technologies, improve production efficiency, and
gradually participate in higher value-added stages of regional supply chains. This
approach will enable Vietnam not only to expand its export scale but also to consolidate
its position within the APAC production network.

3. Improving Logistics Infrastructure and Trade-Facilitating Services

Third, the positive impact of trade in services highlights the increasing importance
of service sectors such as logistics, finance, information technology, tourism, and
transportation in facilitating merchandise trade. For Vietnam, logistics costs remain
relatively high compared with the regional average, thereby reducing profit margins and
export competitiveness. Accordingly, Vietnam should continue investing in port
infrastructure, warehousing, and logistics centers, while accelerating the digitalization of
customs and trade procedures to reduce clearance times and transportation costs. The
development of modern service industries, particularly e-commerce, information
technology, and digital financial services, will not only directly expand service export
volume but also strengthen production activities and merchandise exports. For an
export-oriented economy like Vietnam, improving the quality of trade-facilitating
services is a core factor in enhancing regional competitiveness.

4. Leveraging Political Stability through Institutional Reform

Fourth, although the political stability index exhibits a negative coefficient in the
model, this result reflects structural differences among the economies in the sample rather
than implying that instability promotes trade. In this context, Vietnam, one of the most

61
politically stable countries in the region, should leverage this stability as an advantage to
attract investment and foster trade. However, political stability must be accompanied by
improved institutional quality, especially through policy transparency, reduced
compliance costs for businesses, and enhanced administrative efficiency. Such
improvements will enable Vietnam to establish a more business-friendly environment,
thereby transforming political stability into a driver of trade expansion and deeper
international economic integration.

5. Strengthening Regional Economic Integration

Finally, given the increasingly interconnected nature of regional value chains,

Vietnam should continue to strengthen economic cooperation and deepen integration with
Asia-Pacific economies. Vietnam’s participation in CPTPP, RCEP, and APEC-related
initiatives provides substantial opportunities to expand export markets, attract investment,
and enhance production capabilities. However, to fully capitalize on these agreements,
Vietnam must improve its capacity to meet technical standards, enhance product quality,
and strengthen policy coordination with regional partners in digital trade, services, and
supply-chain harmonization. Such measures will help Vietnam reinforce its position as a
key production destination within the APAC region amid intensifying global trade
competition.
Overall, the study affirms that maintaining competitive prices, strengthening
industrial capacity, developing trade-facilitating services, and improving institutional
quality are essential determinants of trade growth among Asia-Pacific economies. For
Vietnam, these recommendations are particularly significant in the context of accelerating
international integration and upgrading to higher value-added stages within regional
supply chains. The coordinated implementation of these measures will help Vietnam
consolidate the foundations for sustainable export growth, expand trade value, and
enhance long-term economic competitiveness.

62
 CONCLUSION
APAC is an open and highly promising market with strong economic development
needs. Along with this, trade activities have expanded significantly, particularly
import-export operations, which play an essential role in the region’s overall economic
structure. In the context of growing global volatility and increasingly complex economic
challenges, research on the determinants of export performance has attracted substantial
academic interest.
Building upon macroeconomic theory, international trade theory, and the analytical
foundations of Purchasing Power Parity (PPP), this study investigates both the theoretical
and empirical factors influencing export performance in Asia-Pacific economies. By
examining how relative price levels and cost differentials shape international
competitiveness, the research approaches the issue from a macroeconomic and
international trade perspective. Based on this analytical framework, the study quantifies
the extent to which PPP differences affect the export value of Asia-Pacific countries
during the period 2002-2023. The findings provide empirical evidence on how variations
in purchasing power may enhance or weaken a country’s export capacity.
In addition, the study proposes policy recommendations and strategic measures for
governmental authorities to support and strengthen Vietnam’s export activities,
particularly in the context of deepening regional economic integration and widening
price-level disparities among economies. Compared with previous research, this study
incorporates updated data, applies a systematic modeling approach, and extends the
analysis over a longer time horizon.
However, certain limitations remain. The study focuses primarily on key
macroeconomic determinants and faces constraints in accessing several important
secondary data sources, which may restrict the comprehensiveness of the analysis. These
limitations should be addressed in future research. Despite these constraints, the study
contributes both theoretically and practically by validating earlier findings and enhancing
the conceptual framework for understanding export performance through the lens of
purchasing power and macroeconomic competitiveness.

63
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 APPENDIX
Appendix A: Empirical Results
Figure A1. Frequency and Proportion of Missing Values

(Source: Authors' calculation using Stata)

Figure A2. Summary of Variables

(Source: Authors' calculation using Stata)

Figure A3. Matrix of Correlations

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 (Source: Authors' calculation using Stata)
Figure A4. Initial Regression Results

(Source: Authors' calculation using Stata)

Figure A5. Variance Inflation Factor (VIF)

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 (Source: Authors' calculation using Stata)
Figure A6. Skewness and Kurtosis for Normality

(Source: Authors' calculation using Stata)

Figure A7. Breusch-Pagan Test for Heteroskedasticity

(Source: Authors' calculation using Stata)

Figure A8. Arellano-Bond Test for Autocorrelation

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 (Source: Authors' calculation using Stata)
Figure A9. Regression with Driscoll-Kraay Standard Errors

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(Source: Authors' calculation using Stata)

75