The Trade Collapse: Lining Up the Suspects
Contessi, Silvio, El-Ghazaly, Hoda, Regional Economist
Along with the spread of the financial crisis that began in 2007, the world experienced the largest recession since the Great Depression. According to the International Monetary Fund, world GDP fell by 0.8 percent in 2009, while advanced economies experienced a contraction of 3.2 percent, the largest decline in the past 50 years. Exports from the advanced economies fell even more, by a staggering 12.3 percent, about four times as much as the drop in GDP and approximately as much as exports to the advanced economies.
The figure shows the rate of growth of U.S. GDP, imports and exports, as well as a pattern that was common to many other countries during the crisis: The imports and exports of advanced, emerging and developing economies fell by similar percentages, ranging from a minimum of 11.7 percent to a maximum of 13.5 percent. Similarly, the rebound of U.S. trade flows that appears in the figure at the end of 2009 was observed in other countries.
The larger-than-expected drop in trade has puzzled economists and commentators throughout the current recession. A number of trade scholars are looking into potential culprits.
The suspect that can be easily discarded is trade restrictions. Unlike during other recessions and the Great Depression, countries have not used trade measures-such as tariffs, quotas or anti-dumping measures-during this recession to restrict imports. One reason is the World Trade Organization forbids these measures; another reason is we now understand that trade restrictions worsened the Great Depression.
The remaining causes for the plummet in exports are more difficult to discard: the collapse of trade finance, the increase in vertical specialization and the composition of trade flows. Traditional textbook analysis of trade dynamics during recessions attributes trade decline to lower demand for final good imports in the country experiencing a contraction. However, the changes in the way trade is financed and organized, along with a better understanding of the international economy, induced economists to focus on the three elements we discuss here.
First Suspect: Finance
Various studies have documented the importance of finance for international trade transactions, as financial institutions are key suppliers of services such as the evaluation of counterparty default risk and the provision of payment insurance and guarantees to exporters. Economist Marc Auboin estimated that about 90 percent of international trade transactions rely on one form or another of trade finance.
Therefore, the conjecture is that the credit crunch may have caused the large decline in world trade by reducing firms' access to finance. A study by economists Mary Amiti and David Weinstein has shown that a similar mechanism was at work during the Japanese crisis of the late 1990s and early 2000s. They found that lack of financing accounted for nearly one-third of the plunge in Japanese exports during the 1990s.
Fresh evidence for the current recession is hard to come by and to date exists only for exports to the U.S. Economists Davin Chor and Kalina Manova found that countries with tighter credit availability during the crisis exported less to the U.S. Moreover, exports to the U.S. contracted more in sectors that other research has shown to be more heavily dependent on extensive external financing. This early evidence suggests that the trade finance nexus seems to be one of the explanations of the trade contraction during the current crisis, at least for the U.S.
Second Suspect: Vertical Fragmentation
The second suspect is vertical fragmentation, a form of international trade that has been growing exponentially with the spread of globalization in the past 20 years. We normally think of international trade as being dominated by final goods, those that do not need further processing. On the contrary, the data show that international trade in industrialized countries is dominated by capital goods (such as machinery) and other types of intermediate goods (such as steel) that are normally used for the production of consumer goods. …