Follow the Bouncing Ball

The current recession has been accompanied by dramatic changes in trade. Figure 1 presents the pattern of OECD trade as the crisis unfolded. There is a time lag in these data. The trends in trade in late 2008, first spotted in early 2009, invited a mix of consternation and hyperbole in the business and economics press and blogosphere alike. Through the summer of 2009, discussion ranged from worries about export credit shortfalls to resurgent import protection. The focus has been on finding the cause, and the assumption has been that the collapse in trade is unprecedented, inconsistent with the general level of economic downturn, and indicative of a trade-related set of problems calling for trade-specific solutions. Yet, there may actually be two puzzles here. The first is the dramatic fall in trade as the recession deepened. The second is the apparent rebound in trade in the most recent data. What we may be witnessing is an exaggerated collapse and bounce, greater that the corresponding drop and recovery in OECD GDP levels. Applying Occam’s razor, the simple explanation fits the data nicely. Trade has followed the sector composition of the recession.

In the emerging academic literature on trade and the crisis, the papers closest to the points we highlight here focus on the sector composition of the downturn and trade. One set of explanations for the increased sensitivity of trade to GDP swings includes increased complexity in production. Freund (2009), for example, highlights fragmentation in production. She also notes that durable goods are most affected, historically, by financial downturns. This includes iron and steel. McKibbin and Stoeckel (2009) work with a CGE model modified to include elements of the financial crisis. They find that the drop in durables is much higher than for non-durables. In addition, the bursting of housing bubble was identified as being most responsible for the drop in consumption and imports, while the change in assessment of risk was largely responsible for the drop in investment. Also working with a CGE model, Bénassy-Quéré, Decreux, Fontagné, and Khoudour-Castéras (2009) emphasize that a large part of the recent drop in the level of trade is linked to price rather than volume effects. They also stress the importance of using appropriate price deflators. GDP price deflators can lead to substantial overestimating of trade volume changes in economic downturns. Willenbockel and Robinson (2009) also use a CGE model, focusing on developing countries and the collapse in global commodity prices as the downturn unfolded. Borchert and Mattoo (2009) focus instead on the relative stability of trade in the crisis. Indeed, in the case of India, the relative service intensity of India’s trade profile served to dampen swings in total trade during the crisis.

Figure 2 presents a quarterly breakdown for the U.S. of GDP and export trends as the recession unfolded in 2008 and early 2009. In the first quarter of 2009, GDP was down at an annual rate of 6.5%, while exports fell 29.9% at an annual rate. Production of goods was down at an annualized 16.4% in the fourth quarter of 2008 and another 8.7% in the first quarter of 2009. Exports of goods were down a striking 25.5% in the fourth quarter of 2008 and 36.9% in the first quarter of 2009. Services production, on the other hand, only fell at an annualized 0.9% in the first quarter 2009, while exports fell at a rate of 13.6%, roughly 1/3 the fall in goods trade in the same period. This pattern is similar to the observations made by Borchert and Mattoo (2009) regarding India. Even at this level of aggregation, it is clear that the goods-side of the U.S. economy has been hit harder than the services side, both in terms of production, and also trade volumes.

To better understand what has been happening to total trade flows in goods, we now turn to a more detailed discussion of the sector composition of production and trade. Figure 3 presents the change in real U.S. goods exports by quarter, in 2007 dollars, by major end use category. From the figure, almost all of the drop has been in investment & durable goods, and industrial supplies. Indeed, motor vehicles alone account for roughly one-third of the total decline. Basically, the recession has been hardest on heavy manufacturing – machinery, vehicles, and related raw materials. This has translated into a deep manufacturing recession, and a correspondingly deep drop in trade. From the import data, it is clear that roughly half of the drop in U.S. import values at the depth of the trade collapse was actually due to a drop in raw materials like oil (Francois and Woerz 2009). The drop in motor vehicle trade actually maps almost exactly to the drop in U.S. production, a point we return to below.

An important point to keep in mind is that manufacturing has a much greater weight in total trade values than it does in value added. While this is obviously true for the OECD countries (where services are typically 70% of value added but only 20% of trade values), it also holds for major developing economies as well. This is illustrated in Figure 4 below. In the figure, we present a breakdown of China’s patterns of production and trade by major sector. The first column presents value added shares, while the second and third present export and import shares. Transportation and other services account for almost half (48%) of value added in China, but only 11% of imports and 7% of exports. Mechanical and electrical machinery dominates both imports (41%) and exports (40%) yet is only 9% of value added. Textiles and clothing, and resource-based manufacturing, account for another 31% of exports, yet only 11% of value added. Indeed, a great deal of China’s value added is in sectors that, on a gross value basis, contribute relatively little to the external accounts. Like the OECD, such patterns mean that for China, a global recession that hits industrial goods sectors the hardest will also have a disproportionate impact on trade relative to GDP. In contrast, for countries where for historical reasons value added is concentrated in industrial supply and machinery sectors (like much of Eastern Europe) the impact of the recession on GDP has been much greater.

Finally, Figure 5 presents the evolution of U.S. production, imports, and exports in the motor vehicles sector. These are all indexes of production, and so reflect “real” trends from 2007 to 2009. Production is based on number of vehicles, while the trade data are deflated using BEA real and nominal price data for Census-based trade categories. What is clear is that, at the sector level, we have an almost exact mapping between trade and production trends. The collapse of U.S. trade in motor vehicles corresponds to the global crisis in the vehicles sector. Because the motor vehicle sector is a large share of U.S. trade, this has also helped drive the collapse in total U.S. trade (again, see also Figure 4). Indeed, the recovery of U.S. vehicle trade in the third quarter of 2009 as restructuring has progressed and credit lines have been re-established has also contributed to almost half of the annualized 21.4% increase in U.S. goods exports in the third quarter of 2009.

There are potentially important public policy questions lurking behind the trade-recession linkages. Has the recession been compounded by a set of trade-specific problems and issues? If so, how big are these, and should we be worried? In confronting these questions, we need to be careful when comparing real and nominal changes in trade. We have clearly witnessed a dramatic drop in world trade, and may also see an equally dramatic surge. For policy purposes though, an important question is whether the decline is out of line with the global shock to GDP and the underlying credit crisis. At the moment, trade seems to be a victim, but one reflecting non-trade weaknesses in credit and demand. The countries with the greatest trade shocks were also more exposed to sectors hit hard by the recession. They are victims, so far, of the general pattern of recession rather than of systemic protection.

This does not mean we should let down our guard against protection. There may be risks for protection on the upside of the trade cycle that did not materialize on the downside. Antidumping regimes are backward looking, using recent trends in data to establish causal links between injury and trade. If trade surges on the upside as rapidly as it fell on the downside, it may be relatively easily to establish spurious links between recovering import volumes and recession-related ill health at the firm level. Indeed, there is evidence that findings of injury in past business cycles have been a function of general macroeconomic conditions in both OECD and developing country regimes. (Feinberg 1989, Knetter and Prusa 2003, Francois and Niels 2006). So, while the cure for the symptoms lies in curing the underlying illness -- recession linked to a deep credit crisis – it is important to maintain a rearguard action on the import protection front.

Notes:
This post also appears in a slightly different format as part of Richard Baldwin's e-book The great trade collapse on VoxEU: "Follow the bouncing ball – trade and the great recession redux," with Julia Woerz. You can download a pdf version here.

REFERENCES:

Bénassy-Quéré, A., Y. Decreux , L. Fontagné, D. Khoudour-Castéras (2009), “Explaining the steep drop in international trade with mirage,” CEPII working paper.

Borchert, Ingo; Mattoo, Aaditya (2009), “The Crisis-Resilience of Services Trade,” World Bank Working Papers 4917, April.

Robert M. Feinberg (1989), “Exchange Rates and "Unfair Trade," The Review of Economics and Statistics, Vol. 71, No. 4 (Nov., 1989), pp. 704-707.

Francois, J. and J. Woerz (2009), “The Big Drop: Trade and the Great Recession,” VoxEU, March.

Francois, J. and G. Niels (2006), “Business Cycles, the Exchange Rate, and Demand for Antidumping Protection in Mexico,” Review of Development Economics, (3):388-399.

Freund, Caroline (2009), “The Trade Response to Global Downturns. Historical Evidence,” World Bank Working Papers 5015, August 2009.

McKibbin, W.J., and A. Stoeckel, (2009), “Modelling the Global Financial Crisis. Centre for Applied Macroeconomic Analysis,” The Australian National University, Working Paper 25/2009.

Knetter, M. and T. Prusa (2003), “Macroeconomic factors and antidumping filings: evidence from four countries,” Journal of International Economics, 61(1): 1-17.

Willenbockel, Dirk; Robinson, Sherman (2009), “The Global Financial Crisis, LDC Exports and Welfare: Analysis with a World Trade Model,” Munich Personal RePEc Archive Working Paper No. 15377, April.

Trade is Falling, but Credit is not Due to Protectionism (yet)

Alarm bells are ringing. Trade is falling, and so we have rounded up the usual suspect -- import protection. Yet we really have not seen a sustained wave of protection so far, only a wave of anxiety. What we have seen is a real collapse in trade volumes, caused by a mix of falling demand, buyer uncertainty, and an apparent lack of export credits. It is striking that in recent revisions to U.S. GDP statistics for the end of 2008, it now appears that U.S. real exports fell 23.6 percent in the last quarter of 2008, while real imports fell 16.0 percent.

The drop in world trade is very real. The jury is out on the cause. How deep is the collapse? According to Wharton, the Baltic Dsy Index for shipping prices is down 90% from its May 2008 peak. In addition, there is evidence that perhaps half the global shipping fleet is idle. This is the mirror to falling domestic economic activity across the globe. Import protection certainly will not help. However, we need to devote energy to a better understanding of what has driven the collapse so far if we want to address the issue. Credit may be a big part of the picture. Apparently, carmakers in Japan are unable to get loans for their American customers, while exporters in a range of industries complain that lack of credit makes international shipments almost impossible.

References
Countries Stepping in to Finance Export Trade, New York Times, 3 March 2009.
Trade Wars: Will Protectionism Win out over Recovery?, Wharton Knowledge, 18 February 2009.

It is time for me to disagree with myself -- we need both Doha and a trade standstill agreement

In other fora, here and on VoxEU, I have argued that we need to stop focusing on the Doha Round, and move on to real dangers -- like rising protectionism outside the bounds we have placed on MFN tariffs. Times have changed. It is still true that the substance of the Doha Round will not impact the current crisis. A successful agreement would take years to implement, and it does not address the discretionary protection now threatening trade. However, in the present climate, it could serve as a potent symbol of commitment. So, for its value as a symbol, we should conclude it now, even if in a truncated form. To silence the darker voices urging our leaders to shift shared burdens onto others -- the EU has now reintroduced dairy export subsidies for example -- concluding Doha would be a sign that we choose to ignore those dark voices. Even this is not enough. There should be more. The OECD should collectively declare a temporary standstill (24 months?) on discretionary protection. This would mean no antidumping, countervailing, or safeguard actions involving partners (including non-OECD partners) that also adhere to the standstill agreement, as well as a suspension of reintroduced export subsidies, until calmer heads and markets again prevail.


In the absence of a Trade Standstill Agreement, or something of the sort, things will get nasty. Indeed, they already are, judging from headlines just this week. The EU has started to introduce export subsidies, which means they are forcing other countries (including poor producers) to carry their share of the burden linked to depressed agricultural prices. At the same time, the United States Congress is gunning for a weakened China for maintaining an undervalued currency, even though China's exports are falling and the Chinese are needed to buy U.S. bonds and so fund Obama's new initiatives. Antidumping actions will undoubtably surge as the global economy grows worse, as evidenced by India's recent antidumping assault on China. The U.S. Congress is also trying to redirect subsidies linked to antidumping duties back to firms, even though they have been found to violate U.S. treaties. Exporters know this is a losing game. They need to press for a collective cool down period.

Ignore the dark voices. We are in this together. Just say no....

Further reading:

"Producers brace for tariff pain," AUSTRALIAN dairy farmers are under attack after the European Commission launched a barrage of export subsidies on to the world market...., Weekly Times Now, 28 January 2008.

"China slams EU anti-dumping move, threatens WTO action," China Wednesday blasted an EU decision to slap hefty anti-dumping duties on Chinese-made screws and bolts and said it may take the issue to the World Trade Organisation..., AFP 29 January 2009.

"ECONOMIC STIMULUS INCLUDES ANTI-DUMPING RELIEF FOR DOMESTIC LUMBER, STEEL & CEMENT FIRMS," Domestic lumber, steel and cement firms now required to pay back anti-dumping funds they received earlier this decade could seek their bills covered under a provision senators have included in the Finance Committee’s $455 billion economic stimulus measure...,Rotor News 27 January 2009.

"Beware trade wars," The threat to world trade comes from the Omnibus Trade and Competitiveness Act of 1988. Should the Treasury officially determine China to be a currency manipulator, itcould unleash a range of remedies, including antidumping measures, countervailing duties and safeguards..., Willem Buiter FT blog, Published: January 27 2009.

"India begins anti-subsidy probe against China," After setting off an avalanche of anti-dumping probes into a diverse range of manufactured products against China by responding to the domestic industry’s concerns in recent months, the Commerce Ministry has for the first time begun an anti-subsidy probe into imported sodium nitrite from China..., Business Line 29 January 2009.

The GATT (aka the WTO) works

There has been a dispute in the academic literature about the impact of the GATT on trade liberalization. The first shot was a set of papers by Andrew Rose. [1]. His papers have since been savaged by follow-up literature. [2]

The ongoing financial crisis has rendered this literature, quite literally, academic. What I mean is that, basically, the real test is what has just (not) happened. As Doug Irwin noted in his review of the GATT and its transition to the WTO, the first part of the 20th Century -- World War I and the early years of the Great Depression -- were characterized by savagely competitive tariff wars. [3] The framers of the Bretton Woods system had this firmly in mind when they set up the post-War system. [4] We may wonder at times exactly what the IMF and World Bank are doing at the moment. We no longer have to wonder about the GATT (aka the WTO). It is a systemic safeguard, and it seems to be working. Notice the deafening sounds of silence along Smoot-Hawley lines. Indeed, we have calls for further trade liberalization in the WTO. Recent events may also shed a new light on regionalism. In the academic literature, regional agreements have been seen as potential stumbling blocks to the multilateral system. Yet, as safeguards against protectionism in a big global crisis, the EU and NAFTA appear to be complementary safeguards. We have been focused, in much of the literature on the GATT and on regional trade negotiations, on the process of marginal concessions and terms-of-trade manipulation. Aside from all this academic analysis, in the real world the multilateral trading system is doing what it was actually meant to. There will be rising protectionist responses as we sink further into recession. However, as long as the system holds, this will not be broad based.

[1] A.K. Rose (2003), "Do WTO members have more liberal trade policy?" Journal of International Economics Volume 63, Issue 2, July 2004, Pages 209-235.

[2] A. Subramaniana and S-J Wei, "The WTO promotes trade, strongly but unevenly," Journal of International Economics, Volume 72, Issue 1, May 2007, Pages 151-175.

[3] D. Irwin (1995), "The GATT in Historical Perspective," The American Economic Review, Vol. 85, No. 2, pp. 323-328.

[4] J. Toye and R. Toye (2005), "From Multilateralism to Modernisation," Forum for Development Studies, No. 1, pp. 127-150.

[5] K. Bagwell and R. Staiger (1999), "An Economic Theory of the GATT," The American Economic Review, Vol. 89, No. 1, pp. 215-248.