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Re-thinking Trade Models - Why did Trade Collapse During this Crisis?

Raj Nallari's picture

Seventy percent of all trade is trade in goods. World trade volume declined by over 20% from peak levels trough April 2008 to January 2009, and this decline was observed across the board – advanced economies recorded a decline of over 23%, Asia about 25%, and so on. Several explanations were provided. One was that countries were raising tariffs and nontariff measures to protect domestic industries during the global downturn. Now, there is evidence that despite some ‘buy American’ and ‘buy British’ type of fiscal stimulus packages, and notwithstanding the rhetoric of governments, protectionism was muted and almost all countries held up their side of the WTO agreements. Others stressed that decline in economic activity was the primary cause of sharp decline in trade. But as pointed out by Chinn (2009) and others, the decline in US imports was much larger than that warranted by the decline in US GDP. The value of the dollar, as it gained strength during a period of international uncertainty, and the change in relative prices were other plausible explanations, but these too do not fully explain the decline in trade volume across all parts of the world.

There in now growing evidence that the financial crisis caused financial institutions to cutback in trade finance to exporting firms. Modern trade finance is not just letters of credits but guarantees, financing for shipping and insurance, and temporary loans against the collateral of goods and loans for working capital etc. The costs of trade credits jumped up during the crisis. According to one survey of commercial banks in the world, more than 70% reported that prices for letters of credit increased in 2008 and 2009 compared with 2007, while over 90% of those surveyed reported that trade-related loan facilities where charged higher interest rates since the break-out of the crisis. Existing trade models do not incorporate trade finance in their models.

The recent global crisis has also revealed that production and trade is now handled by extensive global supply chains, where components (particularly durable goods) are made and traded a number of times before the final good is assembled and produced. For example, 32% of total trade in 2007 of East Asian comprised of trade in components and parts (up from 13% in 1992). Moreover, these global chains need trade finance for longer periods of time before they can be repaid for their value added. Credit crunch has affected trade finance and hence trade volumes in almost all the countries have declined sharply during the global downturn. Trade models need to capture this phenomenon.

When production is spread across countries, protectionism is likely to be ‘muted’ or takes a different form, such as the ‘murky’ protectionism where distribution of government procurement is in favor of the local firms (despite rhetoric of the need for internationally competitive bidding). In the area of ‘buy national’ policies, WTO notification and review mechanisms may have failed. “Green protectionism” and “services trade protectionism” are other areas where international discipline is now being circumvented.

More attention should be paid to access to trade finance and to production of sharing arrangements.

Comments

Submitted by Anonymous on
The blog has numerous factual errors: 1. Nobody - nobody - blamed the contraction of trade on tariff and non-tariff measures (these, of course, increased in prevalence as an attempt to address popular concerns about rising unemployment). 2. Others may have pointed out that the decline in trade is larger than the decline in U.S. GDP; does this make any sense to even point this out? Has absolutely no economic meaning. Of course trade can rise or fall faster than GDP. 3. Last but bot least, the trade finance channel is by now clearly shown to have had a negligible impact on trade. Trade collapsed as demand and prospects for investment collapsed. Firms continued to manufacture with available inventories, as manufacturing ground to a halt more slowly than trade. Given the predictions of an armageddon in late 2008, it is not hard to see why companies would not want to have a ship full of cars sent to a customer who two months down the road may not be able to pay.

Submitted by CSadkam on
A very insightful piece; I had not thought about how access to trade finance may help/hinder world trade in goods. Is there a link to Chinn (2009)? Perhaps, the World Bank should conduct some research on this front...After all, given Mr. Zoellick's strong stance on trade, such research may help improve the Bank's advocacy on the issue...

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