Why did global trade fall so much during the Great Recession?

by on December 6, 2010 at 7:35 am in Economics | Permalink

Jonathan Eaton, Sam Kortum, Brent Neiman, John Romalis report:

The ratio of global trade to GDP declined by nearly 30 percent during the global recession of 2008-2009. This large drop in international trade has generated significant attention and concern. Did the decline simply reflect the severity of the recession for traded goods industries? Or alternatively, did international trade shrink due to factors unique to cross border transactions? This paper merges an input-output framework with a gravity trade model and solves numerically several general equilibrium counterfactual scenarios which quantify the relative importance for the decline in trade of the changing composition of global GDP and changes in trade frictions. Our results suggest that the relative decline in demand for manufactures was the most important driver of the decline in manufacturing trade. Changes in demand for durable manufactures alone accounted for 65 percent of the cross-country variation in changes in manufacturing trade/GDP. The decline in total manufacturing demand (durables and non-durables) accounted for more than 80 percent of the global decline in trade/GDP. Trade frictions increased and played an important role in reducing trade in some countries, notably China and Japan, but decreased or remained relatively flat in others. Globally, the impact of these changes in trade frictions largely cancel each other out.

In my view they have nailed it.  To the extent international trade consists of durables, that is why trade declined so sharply, because durables purchases fell.  Contractions in trade credit had much less of a role.

I should add, by the way, that this paper proves the value of real business cycle theory.  Even Keynesian economics (and other AD-deficiency theories) rely on RBC for many of the core mechanisms of business cycle transmission and persistence.  

1 liberalarts December 6, 2010 at 3:54 am

Perhaps this suggests that Smoot-Hawley was not so much of the villain in the Great Depression?

2 Jonathan December 6, 2010 at 4:26 am

OHOC – Obvious hypothesis Obvious Conclusion? 'Our results suggest that the relative decline in demand for manufactures was the most important driver of the decline in manufacturing trade'

3 Jonathan December 6, 2010 at 4:50 am

(other) Jonathan,
It may seem obvious once you build the model and run the numbers, but it isn't obvious ex ante. Check out http://www.voxeu.org/index.php?q=node/4297 for a (partial) list of potential hypotheses to explain the trade collapse.

4 Jim B. December 6, 2010 at 8:13 am

First, I would look at where the sharpest increase in trade was before the recession: intermediate goods. That, plus the fact that "trade" is not a value-added concept – the accounting of an exported finished good includes the value of its imported intermediate goods. Thus, when demand for finished goods falls by any certain amount, trade is likely to fall by much more as the cumulative value of traded inputs falls correspondingly.

5 Right Wing-nut December 6, 2010 at 10:08 am

TG: When you turn off a tap, the water doesn't stop going down the drain immediately. The banks had been slicing & dicing loans specifically so that they could hide the bad loans that they were being forced to make. Being well motivated in this regard, the capacity to hide exceeded the demand until we ran out of people to lure into the housing bubble. At that point, you had all these ARMs out that were designed to be laughably easy to make for a couple more years. Until then, the banks & etc could use these bad loans as good money & behave as if they were solvent.

I'm no expert on what happened next, but I'm betting that the ARMs coming due is was exploded the visible bad debt.

6 malcolm December 7, 2010 at 5:18 am

Hmmm. Equilibrium model driven by technology shocks. Real Business Cycle theory really nailed the last recession.

7 Matt Fitz December 9, 2010 at 1:45 pm

International trade is based on a lot of durable goods and when the recession hit the ratio of global trade to GDP decreased by a lot. We'll ovbiously it would if most our economy is based on importing and exporting durable goods, whos purchases decreased significantly during the 2008-2009 recession.This would cause manufacturers to produce less because the demand for durable goods has also decreased, overall lowering the GDP.

Comments on this entry are closed.

Previous post:

Next post: