'The Great Trade Collapse: What Caused It and What Does It Mean\r'

'The commodious(p)(p) polish off wear disclose: What crusaded it and what does it blotto? Richard Baldwin 27 November 2009 introduction avocation belowgo a fulminant, aid somewhat, and synchronised come apart in novel 2008 †the acuateest in recorded fib and deepest since WWII. This ebook †written for the humanss mete place ministers gathering for the WTOs slew Ministerial in Geneva †pre directs the economics professions received wisdom on the intermit. twain dozen chapters, written by leading(a) economic experts from across the globe, summarise the latest explore on the causes of the get around as whole approximately as its consequences and the prospects for reco precise.According to the emerging consensus, the collapse was caused by the sudden, loathsome and glob anyy synchronised holdup of purchases, especi anyy of change little consumer and coronation goods (and their split and comp 1nts). The concern was amplified by â€Å" mel odic themeal” and â€Å" synchronisation” heart and souls in which universewide proviso durance played a aboriginal agency. The â€Å" vast con bunk collapse” occurred amongst the third low-down of 2008 and the second sink in of 2009. Signs atomic number 18 that it has ended and recuperation has begun, scarce it was huge †the steepest go across of field ap grant in recorded history and the deepest downf completely since the owing(p) Depression.The slump was sudden, severe, and synchronised. A a couple of(prenominal) facts justify the label: The bully administer Collapse. It was severe and sudden orbiculate manage has dropped forwards †three clock since WWII †save this is by off the beaten overlay(predicate) the grownupst. As augur 1 shows, planetary swap vaporize for at least three lodge during three of the humanitywide recesss that require occurred since 1965 †the anoint- horrify street corner of 1974 -75, the inflation-defeating recession of 1982-83, and the Tech-Wreck recession of 2001-02.Specifically: •The 1982 and 2001 drops were comparatively mild, with egression from the forward year’s quarter reaching -5% at the most. •The 1970s shell was twice that size, with step-up stumbling to -11%. •Today collapse is a good deal worse; for 2 accommo time in a row, world handicraft flows take over been 15% below their previous year levels. The OECD has monthly selective information on its members’ real peck for the prehistorical 533 months; the 7 widey growngest month-on-month drops among the 533 all occurred since November 2008 ( rede the chapter by Sonia Araujo and Joaquim Oliveira). witness 1 The large(p) mint collapses in historic attitude, 1965 †2009 character reference: OECD Quarterly real duty selective information. The expectant craftiness collapse is non as large as that of the Great Depression, just it is more than steeper. It took 24 months in the Great Depression for world manage to fall as far as it leave expose in the 9 months from November 2008 (Figure 2). The latest data in the figure (still somewhat preliminary) suggests a recovery is underway. Figure 2 The great(p) vocation collapses vs. the Great Depression kickoff: Eichengreen and O’Rourke (2009), based on CPB online data for latest.It was synchronised •All 104 nations on which the WTO reports data experienced a drop in both imports and exports during the second half of 2008 and the initial half of 2009. •Figure 3 shows how imports and exports collapsed for the EU27 and 10 early(a) nations that together account for three-quarters of world affair; each of these cope flows dropped by more(prenominal)(prenominal) than 20% from 2008Q2 to 2009Q2; numerous fell 30% or more. Figure 3 The great handicraft collapse, 2008 Q2 to 2009 Q2 extensions: WTO online database.Figure 4 shows that world change in virt ually all product categories were positive in 2008Q2, roughly all were prohi enactment in 2008Q4, and all where negative in 2009Q1. The categories most attach by world(prenominal) tack chains (Mechanical and electrical machinery, Precision instruments, and Vehicles) saw some of the cosmicgest drops, and detailed empirics in the chapter by Bems, keisterson and Yi discerns that hang on chains were hit harder controlling for other factors. The chart, however, shows that the travel were by no subject matter extraordinary large in these arenas.Figure 4 All types of goods slyness collapsed simultaneously Source: Com tack database. Manufactures and commodities Trade collapsed across the board, save it is measurable to distinguish between commodities and manufactures. The collapse in minerals and anele flock started from a nail prison term and fell faster than heart and soul job (Figure 5). The reason was prices. Food, materials and especially oil experienced a steep fountain up in price in early 2008; the boom ended in mid 2008 †well before the family line 2008 Lehman’s debacle. The price of manufactures, by contrast, was instead steady in this period (Figure 6).Figure 5 The great dispense collapse and value: Food, oil, and manufactures Source: ITC online database. Since food, fuels, and raw materials make up about a quarter of globose grapple, these price movements had a big dissemble on aggregate look at figures. Countries subordinate on commodity exports, in special(prenominal) oil exporters, were among those that experienced the greatest drop in exports (see the chapters Africa by Peter Draper and Gilberto Biacuana, and by Leonce Ndikumana and Tonia Kandiero, and on India by Rajiv Kumar and Dony Alex).The drop in manufactures get by was also broad, provided it refer mostly quantity reductions. Exporters specialising in durable goods manufactures saw a occurrencely sharp decline in their exports (see chapters on la cquer by Ruyhei Wakasugi and by Kiyoyasu Tanaka). Mexico, which is both an oil exporter and a participant in the US’s manufacturing tack chain, experienced unrivaled of the world’s most severe craft slumps (see chapter by Ray Robertson). Figure 6 The great trade collapse and prices: Commodity vs. manufactures Source: CPB online database. CausesThe great trade collapse was triggered by †and helped short-circuit †the globular economic slump that has come to be called â€Å"The Great Recession. 1 As the leftover panel of Figure 7 shows, the OECD nations slipped into recession in this period, with the largest importing market places †the US, EU and lacquer (the G3) †seeing their gross domestic product growth plump out more or little in synch. The US and Europe saw negative gross domestic product growth rates of 3 to 4%; Japan was hit far worse. Figure 7 The current recession, OECD nations and G3, 2007Q1 †2009Q2 course: G3 is US, EU and Japan. Source: OECD online data base. wherefore did trade fall so much more than gross domestic product? Given the globose recession, a drop in global trade is unsurprising. The question is: Why was it so big? The chapter by Caroline Freund shows that during the four large, authoritywar recessions (1975, 1982, 1991, and 2001) world trade dropped 4. 8 clock more than gross domestic product (also see Freund 2009). This cartridge holder the drop was far, far bigger. From a historical perspective (Figure 8), the drop is astonishing. The figure shows the trade-to-GDP symmetry rising steeply in the late 1990s, before stagnating in the new ampere-second right up to the great trade collapse in 2008.The rise in the 1990s is explained by a spot of factors including trade liberalisation. A cite driver, however, was the fundamental law of external append chains (manufacturing was geographically unbundled with various slices of the value-added process beingness place in nearby natio ns). This unbundling meant that the same value-added cover b poses several times. In a unbiased international supply chain, imported part would be transformed into exported components which were in revoke assembled into last-place goods and exported once again, so the trade figures counted the final examination value added several times.As we shall see, the presences of these highly integrated and tightly synchronised work ne bothrks plays an all primal(predicate) role in the nature of the great trade collapse (see chapters by Rudolfs Bems, Robert Johnson, and Kei-Mu Yi, and by Andrei Levchenko, Logan Lewis, and Linda Tesar). Figure 8 World trade to world GDP dimension, 1980Q1 to 2009Q2 Source: World imports from OECD online data base; World GDP based on IMF data. Emerging consensus on the causes Economists around the world have been operative hard to understand the causes of this unusually large and abrupt shut down of international trade.The dozen chapters in Part II of this book summarise all the key research †most of it do by the authors themselves. They do non all mate on all points, but a consensus is emerging. When gross revenue drop sharply †and the great trade collapse was a coarse drop in international sales †economists look for petition traumatises and/or supply fogs. The emerging consensus is that the great trade collapse was mostly a make traumatise †although supply side factors played some role. The pauperism shock operated through both distinct but mutually reinforcing channel: •Commodity prices †which tumbled when the rice bubble ruin in mid 2008 †crossd to take on world strike in its descending(prenominal) spiral. The price movements and diminished demand sent the value and volume of commodities trade diving. •The production and exports of manufacturing collapsed as the Lehman’s-induced shock-and-awe caused consumers and firms to conceal and see; offstage demand f or all manner of ‘postpone-able’ pulmonary tuberculosis crashed. This second point was greatly amplified by the very particular nature of the demand shock that hit the world’s deliverance in September 2008. Why so big? This consensus view, however, is incomplete.It raises the question: If the trade drop was demand driven, wherefore was the trade drop so much larger than the GDP drop? The answer provided by the emerging consensus is that the nature of the demand shock interacted with â€Å"compositional” and â€Å"synchronicity” results to greatly exaggerate the movement of the trade-to-GDP ratio. Compositional onus The compositional effect turns on the eccentric nature of the demand shock. The demand shock was very large, but also cogitate on a narrow verify of domestic value-added activities †the production of â€Å"postponeable” goods, consumer durables and investment funds goods.This demand drop immediately, reducing demand fo r all related intermediate in ranks (parts and components, chemicals, steel, etc). The compositional-effect affirmation is founded on the fact that postponeables make up a narrow slice of world GDP, but a very large slice of the world trade (Figure 9). In a nutshell, the common cause of the GDP and trade collapse †a sudden drop in the demand for postponeables †operated with full force on trade but diminished force on GDP due to the compositional difference.The large demand shock applied to the near-totality of trade objet dart entirely applying to a thin portion of GDP. Here is a simple example. 2 Suppose exports consisted of 90% â€Å"postponeable” (consumer and investment electronics, bear equipment, machinery and their parts and components). GDP, however, consists most of non-tradeables (services, etc). Taking postponeables’ assign in US GDP to be 20%, the pre-crisis situation is: When the sales of postponeables slumps by, say, half, the numerator fal ls much more than the denominator.Assuming that ”other” continues growth in trade and GDP by 2%, the post-crisis trade to GDP ratio is Exports have fallen 44. 8% in this example, while GDP has fallen only 8. 4%. In short, the different composition of trade and GDP, taken together with the particularized nature of the demand shock, has resulted in trade falling more than 5 times as fast as GDP. secure the chapter by Andrei Levchenko, Logan Lewis, and Linda Tesar for a careful probe of this logic using detailed US production and trade data; they drive that the compositional effect accounts for most of the US trade drop.The chapter by Joseph Francois and Julia Woerz uses US and Chinese data to argue that the compositional effect is key to understanding the trade collapse. 3 Figure 9 Composition of world goods trade Source: WTO online database for 2007. Synchronicity effect The synchronicity effect helps explain why the great trade collapse was so great in an even more d irect manner; most any nation’s imports and exports fell at the same time. There was none of the averaging out that occurred in the three other postwar trade drops. But why was it so synchronised?There are two leading explanations for the remarkable synchronicity. The first of all concerns international supply chains, the second concerns the ultimate cause of the Great Recession. The profound internationalisation of the supply chain that has occurred since the 1980s †specifically, the just-in-time nature of these vertically integrated production networks †served to coordinate, i. e. quickly transmit, demand shocks. Even a decade ago, a drop in consumer sales in the US or Europe took months to be transmitted back to the factories and even long-acting to reach the suppliers of those factories.Today, Factory Asia is online. Hesitation by US and European consumers is transmitted almost instantly to the entire supply chain, which reacts almost instantly by producing and purchasing less; trade drops in synch, both imports and exports. For example, during the 2001 trade collapse, monthly data for 52 nations shows that 39% of the month-nation pairs had negative growth for both imports and exports. In the 2008 crisis the figure is 83%. For details on this point, see Di Giovanni, Julian and Andrei Levchenko (2009), Yi (2009), and the chapters by Rudolfs Bems, Robert Johnson, and Kei-Mu Yi, and by Kiyoyasu Tanaka.The second explanation requires a bit of background and a bit of presuppose (macroeconomists have non arrived at a consensus on the causes of the Great Recession). To understand the global shock to the demand for traded goods, we regard a thumbnail sketch of the global crisis. How the subprime crisis became the global crisis The â€Å"Subprime Crisis” bust out in fantastic 2007. For 13 months, the world viewed this as a pecuniary crisis that was mainly stay onricted to the G7 nations who had mismanaged their monetary and reg ulative policy †especially the US and the UK.Figure 3 shows that world trade continued growth apace in 2007 and early 2008. The crisis metastasised from the â€Å"Subprime Crisis” to the global crisis in September 2008. The defining trice came when the US exchequer allowed the investment assert Lehman Brothers to go swanrupt. This shocked the global pecuniary community since they had assumed no major pecuniary institution would be allowed to go under. Many of the remaining financial institutions were essentially avowrupt in an accounting sense, so no one knew who tycoon be adjacent. coasters stopped lending to each other and honorable boot markets froze.The Lehman bankruptcy, however, was just one of a half dozen â€Å"impossible points” that occurred at this time. Here is a short cite of others:4 •All big investment banks disappeared. •The US Fed lent $85 billion to an indemnification company (AIG), acquire money from the US Treasur y to cover the loan. •A US money market fund lost so much that it could non repay its depositors capital. •US Treasury Secretary Paulson asked the US Congress for three-quarters of a trillion dollars based on a 3-page proposal; he had difficulties in answer direct questions about how the money would pay back the bother. The hereto laissez-faire US Securities and veer Commission banned short marketing of bank stocks to slow the drop in financial institutions stock prices. It didn’t work. •Daniel Gros and Stephano Micossi (2009) pointed out that European banks were too big to separate and too big to save (their assets were often multiples of the their home nations’ GDPs); •Congress said â€Å"no” to Paulson’s ill-explained plan, promising its own version. As hatful around the world watched this unassured and ill-explained behaviour of the US government, a massive feeling of insecurity formed.Extensive research in behavioura l economics shows that people tend to act in extremely fortune averse ways when gripped by upkeeps of the incomprehensible (as opposed to when they are faced with risk, as in a coarse-grained of cards, where all outcomes can be enumerated and assigned a probability). Fall 2008 was a time when people really had no idea what might happen. This is Ricardo Caballero’s hypothesis of â€Å"Knightian Uncertainty” (i. e. the terror of the unk this instantn) which has been endorsed by the IMF’s chief economist Olivier Blanchard. Consumers, firms, and investors around the world decided to â€Å"wait and see” †to hold off on postponeable purchases and investments until they could determine how bad things would get. The delaying of purchases and investments, the even offing of balance sheets and the duty period of wealth to the safest assets caused what Caballero has called â€Å"sudden financial make” (a conscious reference to the usually disast rous medical condition â€Å"sudden cardiac snitch”). The â€Å"fear factor” spread across the globe at profits speed. Consumers, firms and investors all feared that they’d find out what capitalism without the capital would be alike.They independently, but simultaneously decided to shelf plans for buying durable consumer and investment goods and indeed anything that could be postponed, including expensive holidays and leisure travel. In previous episodes of declining world trade, there was no Lehman-like event to synchronise the wait-and-see stance on a global exfoliation. The key points as concerns the trade and GDP collapse: •As the fear factor was propagating via the electronic press; the contagious disease was global and instantaneous. •The demand shock to GDP and the demand shock to trade occurred simultaneously. â€Å"Postponeable” sector production and trade were hit first and hardest. There are a summate of indications that this is the right story. First, global trade in services did not, in general, collapse (see the chapter by Aditya Mattoo and Ingo Borchert). Interestingly, one of the a couple of(prenominal) categories of services trade that did collapse was tourism †the ultimate postponeable. Second, macroeconomists’ investigations into the contagion mechanisms operating in this crisis show that none of the usual transmission vectors †trade in goods, international capital flows, and financial crisis contagion †were esponsible for the synchronisation of the global income drop (Rose and spiegel iron 2009). Supply-side effects The Lehman-link â€Å"sudden financial arrest” froze global quote markets and spilled over on the specialized financial instruments that help smut the gears of international trade †letters of credit and the like. From the earliest days of the great trade collapse, analysts suspected that a lack of trade-credit funding was a contributing factor (A uboin 2009). As the chapter by Jesse Mora and entrustiam Powers argues, such supply-side shocks have been all-important(a) in the past.Careful research on the 1997 Asian crisis (Amiti and Weinstein 2009) and historical bank crises (see the chapter by da Vinci Iacovone and Veronika Zavacka) provide convincing evidence that credit conditions can affect trade flows. The Mora and Powers chapter, however, finds that declines in global trade finance have not had a major impact on trade flows. While global credit markets in general did blank out up, trade finance declined only sanely in most cases. If anything, US cross-border bank pay bounced back earlier than bank financial support from other seminal fluids.In short, trade financing had at most a conduce role in reducing global trade. transnationalised supply chains are a second potential source of supply shocks. One could imagine that a big drop in demand feature with deteriorating credit conditions might produce far-flung ban kruptcies among trading firms. Since the supply chain is a chain, bankruptcy of even a few links could suppress trade on the whole chain. The chapters by Peter Schott (on US data), by Lionel Fontagne and Guillaume Gaulier (on French data), and by Ruyhei Wakasugi (on Nipponese data) present evidence that such disruptions did not occur this time.They do this by looking at very disaggregated data (firm-level data in the Fontagne-Gaulier chapter) and distinguishing between the so-called â€Å"intensive” and â€Å"extensive” perimeters of trade. These margins decompose changes in trade flows into changes in sales across quick trade relations (intensive) and changes in the derive of such relations (extensive). If the supply-chain-disruption story were an important part of the great trade collapse, these authors should have found that the extensive margin was important.The authors, however, find that the great trade collapse has been in the first place driven by the i ntensive margin †by changes in pre-existing trade relationships. Trade fell because firms sold less of products that they were already selling; there was very little destruction of trade relationships as would be the case if the extensive margin had been found to be important. This findings may be due to the notion of ”hysteresis in trade” (Baldwin 1988), namely, that large and sunk market-entry costs regard that firms are reluctant to exit markets in the face of temporary shocks.Instead of exiting, they merely scale back their operations, waiting for better times. Protectionism is the final supply shock commonly discuss as a cause of the great trade collapse. The chapter by Simon Evenett documents the rise in crisis-linked protectionist measures. While many measures have been put in place †on average, one G20 government has broken its no-protection pledge every(prenominal) other day since November 2008 †they do not yet cover a red-blooded fraction of world trade. Protection, in short, has not been a major cause of the trade collapse so far.Prospects The suddenness of the 2008 trade drop holds out the hope of an every bit sudden recovery. If the fear-factor-demand-drop was the driver of the great trade collapse, a confidence-factor-demand-revival could equally drive a rapid redress of trade to big-boned growth. If it was all a demand problem, subsequently all, little long-lasting damage give have been done. See the chapter by Ruyhei Wakasugi on this. There are clear signs that trade is recovering, and it is absolutely clear that the drop has halted. Will the trade revival continue?No one can know the next path of global economic recovery †and this is the key to the trade recovery. It is useful withal to think of the global economic crisis as consisting of two very different crises: a banking-and-balance-sheet crisis in the over-indebted advanced nations (especially the US and UK), on one hand, and an expectations-crisi s in most of the rest of the world on the other hand. In the US, UK and some other G7 nations, the damage done by the bursting subprime bubble is still being felt.Their financial systems are still under severe strain. Bank lending is dull and corporate-debt issuances are problematic. Extraordinary direct interventions by central banks in the capital markets are underpinning the economic recovery. For these nations, the crisis †specifically the Subprime Crisis †has caused lasting damage. Banks, firms and individuals who over-leveraged during what they ideal was the ”great moderation” are now holding back on custom and investment in an attempt to redress their balance sheets (Bean 2009).This could play itself out like the lost decade Japan experienced in the 1990s (Leijonhufvud 2009, Kobayashi 2008); also see the chapter by Michael Ferrantino and Aimee Larsen. For most nations in the world, however, this is not a financial crisis †it is a trade crisis. Ma ny have reacted by instituting fiscal stimuli of historic proportions, but their banks and consumers are in relatively good shape, having avoided the overleveraging in the post tech-wreck period (2001-2007) that afflicted many of the G7 economies.The slender question is whether the damage to the G7’s financial systems will prevent a rapid recovery of demand and a restoration of confidence that will re-start the investment engine. In absence of a vitreous silica ball, the chapter by Baldwin and Taglioni undertakes simple simulations that assume trade this time recovers at the pace it did in the past three global trade contractions (1974, 1982 and 2001). In those episodes, trade recovered to its pre-crisis path 2 to 4 quarters after the nadir.Assuming that 2009Q2 was the bottom of the great trade collapse †again an assumption that would require a crystal ball to confirm †this means trade would be back on track by mid 2010. Forecasts are neer better than the assumpt ions on which they are built, so such calculations must be viewed as what-if scenarios rather than serious forecasts. Implications What does the great trade collapse mean for the world economy? The authors of this Ebook present a remarkable consensus on this.Three points are repeatedly stressed: • spherical trade imbalances are a problem that needs to be tackled. One crowd of authors (see the chapters by Fred Bergsten, by Anne Krueger, and by Jeff Frieden) sees them as one the root causes of the Subprime Crisis. They worry that allowing them to continue is setting up the world for another(prenominal) global economic crisis. Fred Bergsten in particular argues that the US must get its national budget deficit in order to avoid laying the carpet for the next crisis.Another group points to the combination of Asian trade surpluses and persistent high unemployment in the US and Europe as a source of protectionist pressures (see the chapters by Caroline Freund, by Simon Evenett, and by Richard Baldwin and Daria Taglioni). The chapter by O’Rourke notes that avoiding a protectionist bound will require that the slump ends soon, and that severe exchange rate misalignments at a time of rising unemployment are avoided. •Governments should entertain against compliancy in their vigil against protectionism.Most authors mention the point that while new protectionism to date has had a modest trade effect, things need not stay that way. The chapter by Simon Evenett is peculiarly clear on this point. There is much work to be done before economists fully understand the great trade collapse, but the chapters in this Ebook constitute a first draft of the consensus that will doubtlessly emerge from the pages of scientific journals in two or three years’ time. Footnotes 1 See Di Giovanni and Levchenko (2009) for evidence on how the shock was transmitted via international production networks. This is force from Baldwin and Taglioni (2009). 3 Jon Eaton, Sa m Kortum, Brent Neiman and John Romalis make similar arguments with data from many nations in an unpublished manuscript go out October 2009. 4 See the excellent timeline of the crisis by the New York Fed. 5 Caballero (2009a, b) and Blanchard (2009). References Auboin, Marc (2009). â€Å"The challenges of trade financing”, VoxEU. org, 28 January 2009. Baldwin, Richard (1988). â€Å"Hysteresis in Import Prices: The foothold Effect”, American Economic Review, 78, 4, pp 773-785, 1988.Baldwin, Richard and Daria Taglioni (2009). â€Å"The magic of improving global imbalances”, VoxEU. org, 14 November 2009. Bean, Charles (2009). â€Å"The Great Moderation, the Great Panic and the Great contraction”, Schumpeter Lecture, European Economic Association, Barcelona, 25 August 2009. Blanchard, Olivier (2009). â€Å"(Nearly) nothing to fear but fear itself”, Economics Focus column, The Economist bell ringer edition, 29 January 2009. Caballero, Ricardo (2009a) . â€Å"A global perspective on the great financial insurance run: Causes, consequences, and solutions (Part 2)”, VoxEU. rg, 23 January 2009. Caballero, Ricardo (2009b). â€Å"Sudden financial arrest”, VoxEU. org, 17 November 2009. Di Giovanni, Julian and Andrei Levchenko (2009). ”International trade, vertical production linkages, and the transmission of shocks”, VoxEU. org, 11 November 2009.Freund, Caroline (2009a). â€Å"The Trade Response to Global Crises: Historical Evidence”, World Bank working paper. Gros, Daniel and Stefano Micossi (2009). â€Å"The beginning of the end game…”, VoxEU. org, 20 September 2008. Kobayashi, Keiichiro (2008). Financial crisis focussing: Lessons from Japan’s failure”, VoxEU. org, 27 October 2008. Leijonhufvud, Axel (2009). â€Å"No ordinary recession”, VoxEU. org, 13 February 2009. Rose, Andrew and Mark Spiegel (2009). â€Å"Searching for international contagion in the 2008 financia l crisis”, VoxEU. org, 3 October 2009. Yi, Kei-Mu (2009), â€Å"The collapse of global trade: The role of vertical specialisation”, in Baldwin and Evenett (eds), The collapse of global trade, murky protectionism, and the crisis: Recommendations for the G20, a VoxEU publication.\r\n'