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.


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