Wednesday, 24 November 2010

One is not enough. Understanding world trade collapse. Luncheon presentation at the Peterson Institute, Monday November, 29, 2010

The world trade collapse that started in October 2008 and reduced global trade by some twenty per cent in only a few months time remains one of the most puzzling phenomena of the last decade. In mid-2009 a consensus amonst trade economists appeared to have emerged. The concensus can be summarized in two ways. Many economists argue that the trade collapse was a demand shock multiplied by a composition effect (the 2009 edited volume by Richard Baldwin is an example). The other view in the profession (of which the WTO in 2009 is an example) is that the trade collapse was caused by protectionism, lacking trade finance and the fragmentation of production in international value chains (the latter incidentally is seen to be a driver of composition effects).

My problem with both representations of the consensus is that they are based on empirical analyses of post Second World War data only. Economists typically do not include the Black Swan of the 1930s in their analysis. This would seem to be simply inappropriate for the analysis of world trade collapse essentially because it is thus implicitly treated as a unique event and actually ‘such events can only be explained historically as they defy the laws of economics’.

In order to fix this methodological problem I study the drivers of import collapse in a data set that comprises 27 economies in the 1930s and 45 economies in the 2000s using variables for which comparable data are available for both periods. Both the demand shock and the composition effect are comparatively speaking much less important in the recent trade collapse than in the 1930s. Institutional factors are important for both periods (this is a factor that is completely lacking in the mainstream narrative). In particular I find that the decline of imports is stronger in centralized autocratic economies which offers circumstantial evidence for my theory that a shock in trade uncertainty is a major cause of the strength and speed of the trade collapse.

Finally I find that the share of manufacturing was an important determinant of the collapse of imports in the 1930s, nut much less so. This is a remarkable and exciting finding given the profession’s early and outspoken conviction that supply chains were a (if not the) driver of the extraordinary trade developments in late 2008 and early 2009. The correlation between international value chain activity and globalization in the period before the trade collapse (that constitutes the basis for the main stream narrative on the impact of value chain activity on openness and international trade) may be genuine but requires a different interpretation. Globalization is a firm driven process and fragmentation of production according to the available evidence has been associated with an increase in the world’s trade-to-GDP-ratio. The underlying mechanism may, however, be quite different from the purely mechanical statistical relationship that relates to the different modes of measurement regarding GDP (value added) and trade (turn-over). Value chain interaction may bread trust amongst participating firms because of the repeated-buy character of the transactions and/or have external effects (such as demonstration effects, learning effects or network effects) which support globalization. If this is the case, there is no reason why this role should be asymmetrical (positive in upswings and negative in downturns) as assumed by the dominant narrative.

This has important implications both for the analysis and for policy advice, in particular the idea of stabilizing economies by means or a reorientation towards domestic production. In contrast my findings imply that additional efforts are in order to increase trust in the trading system in particular by a firm commitment to the multilateral approach.

Friday, 19 November 2010

Ref.: Ms. No. IEEP-D-10-00038
International Value Chains and The World Trade Collapse: A Cross-Country Perspective
International Economics and Economic Policy

Dear prof dr van bergeijk,

Reviewer's comments on your work have now been received. You will see that it is advising against publication of your work. Therefore I must reject it.

For your guidance, I append the reviewer's comments below.

Thank you for giving us the opportunity to consider your work.

Yours sincerely

Thomas Domeratzki
Editorial Assistant
International Economics and Economic Policy

Reviewer's comments:

Reviewer: Summary

The paper "International Value Chains and the World Trade Collapse: A Cross Country Perspective" examines the role of vertical value chains in the trade collapse of 2008/09. Using a cross-country estimation, the decrease in imports between 2008-2009 is regressed on the degree of vertical value chains (as measured by (i) manufacturing products in total imports and (ii) an index capturing the degree of vertical specialization) as well as some control variables. In focusing on imports as endogenous variable, the paper differs from traditional contributions that primarily investigate the effects on export flows. Also, the results differ from the recent literature with respect to causality: The author argues that vertical fragmentation is not amplifying but rather dampening the trade crunch of 2008-2009. The subject of the paper is interesting and, as it refers to the actual trade collapse, it also fits into a growing part of the international trade literature. However, the role
of vertical value chains in the trade collapse is not well established in the paper.

Major Points

I. The paper is not well motivated. Apart from the fact that the analysis of trade in 2008-2009 attracts interest by its own, the paper does not present any motivation on why to study this issue. Moreover, the introduction does not contain a specific literature review that discusses the current state of contributions in the field. To be sure, the author mentions some papers, however, without discussing any results. He solely mentions econometric techniques that are used by other contributions in order to motivate that there is a lack of cross section analysis that he tries to fill with this paper. The absence of a detailed discussion of previous results raises several questions, especially with respect to the economic crisis, where there is a time structure intrinsic to the phenomenon. E.g.: why should there be the need to abstract from the time series? Furthermore, as the results in this paper contradict with the current view on the role of the sourcing mode for the
strength and duration of the crisis, the introduction should include a discussion on causalities and not exclusively on econometric technology. On this account, the reader expects a survey as regards the state of the art, the results thus far, what drove these results (i.e. causalities) and why (the true) causalities might differ from those presented in the literature thus far.

II. The author mentions that the data is preliminary and will be "updated and revised in the next quarters". Since the contribution of the paper is solely an empirical one, it is disputable if one should employ a preliminary dataset, especially if, in addition, key results conflict with the state of the literature.

III. Since the results in this contribution claim the exact opposite of what we know from the recent literature, the author may want to extend the analysis in a number of ways, in particular:

1. First, why do other contributions arrive at the result that international value chains amplify the trade crisis? What is the story and the theoretical reasoning behind those findings?

2. Second, the reader misses sort of a formal model or at least a discussion on how the results attained in this contribution can be explained. Why does vertical fragmentation dampen rather than amplify the trade crisis here?

3. The econometric estimation is characterized by some problems that need to be addressed:
3.1 There should be a serious endogeneity problem between import flows and vertical fragmentation (or manufacturing inputs as a share of imports) that at least requires discussion in the paper. Even if the author is able to tackle this problem by focusing on exogenous variables that are observed before the time of the crisis, the point should be discussed, whether this time structure is suitable for solving the endogeneity problem, or whether there should be other instruments used in order to deal with this problem.
3.2 Is it really possible to examine the role of fragmentation in the trade collapse when having access to data that covers only such a short period of time?
3.3 The index of vertical specialization that is used is not defined neither is it explained. The author draws on data from an OECD report without explaining how the index is defined and what the index is capturing. Since "vertical specialization" is by no means a clearly defined phenomenon (see the extensive literature on this and the variety of measures that has been used thus far), it is necessary to explain exactly what is used as main exogenous variable.

4. Since the analysis is fragile, conclusions and policy recommendations provided in section 5 need to be framed more carefully.

Minor Points

I. The text and the writing is somewhat sloppy (lots of typos etc.)

II. In the regression equations on p.8, there is the constant missing. In addition, there are no subscripts indicating countries, changing rates, levels, etc. Generally speaking, the author may want to be more exact when presenting formulas and math.

III. The usage of the exogenous control variables could be expanded. Maybe the author could explain why not to use the GDP variable in regression 2?

IV. Presenting the t statistic additional to the p value is useless in the discussion of the regression results. When explaining results, it is common practice to talk about significance levels of 1, 5 or 10 percent and not the inverse levels of 90, 95, or 99 percent.