Wednesday, 1 December 2010

The financial crisis, the import collapse and the developing countries

Despite green shoots in the OECD and strong growth rates in China and India the world economy is not out of the woods yet. In 2007 the most serious global economic crisis since the 1930s started and many developing and emerging economies (DEEs), that since the mid 1990s had opened up to the world economy, are now experiencing the down side of strategies that - for good reasons - relied heavily on international trade and foreign direct investment to achieve national development.

What was expected
When the financial crisis burst out in 2007 the majority of economists was not expecting the DEEs to be hit hard. A first, often-mentioned, reason was that developing countries had not engaged in the kind of financial whiz-kidding that had created the enormous bubble in the OECD. Thus it was assumed by many analysts that the DEEs would not suffer a fall-out from the banking crisis which after all was a problem of the OECD countries. A second reason was the myth of decoupling: the non OECD, in particular the BRIC countries (Brazil, Russia, India and China) were assumed to have reached sustainable momentum in their development trajectory. It was expected that the experience of the dotcom crisis (when the BRICs were able to show continuous growth independently of the weakening OECD business cycle) would be repeated.
Both ideas were dangerous and wrong (and actually not new at all as the belief that the periphery could escape the financial collapse in the centre was also widely shared in the early 1930s when it proved to be erroneous). It is true that some of the BRICs continued to grow considerably but the sustainability of growth in 2010 and beyond is not self-evident because the main driver of those expansions (monetary and fiscal stimulus) cannot be expected to last forever. More importantly, smaller DEEs probably did not experience this momentum and may have been hit hard.

What is happening
We do not yet know what happened in many countries, simply because real time data for a sufficient level of analysis are not available. This means that we have to do some economic detective work and use the method of indirect observation to infer if and how the crisis hits the DEEs. We can, for example, take a look at more aggregate data in order to glean the impact of the crisis on the DEEs. In today’s world many channels exist through which economies are linked. International flows such as remittances, bank lending, migration and development aid are influenced by the downturn in OECD economies. An example is the amount of Official Development Aid (ODA). Last year the OECD’s
Often the measurement of these flows is imprecise and data become available with considerable delay. Better data exist for Foreign Direct Investment (FDI) and especially for international trade and therefore we will take a closer look at these international flows. After six years of uninterrupted growth, FDI flows to developing and transition economies, according to 
Some argued that these developments could be a symptom of a process of deglobalization. Others blamed a collapse of trade finance (which is particularly relevant for DEEs) and an increase in protectionism for the declines. It is, however, important to note that the trade and investment contractions took place in a policy context that by and large appeared to have been withstanding the temptations of protectionism and, moreover, the G20 made additional trade financing of US$250 to US$400 billion available, including instruments to mitigate risks and liquidity support. The collapse of international exchange, in other words, could have been much larger if inappropriate policy responses had occurred.

 
Informative as such observations may be, they do not yet provide an indication of the actual impact of the crisis in individual countries. If we want to observe the impact of the crisis on a specific country, one of the best methods is to observe the development of the volume of imports. This is so because trade flows, unlike more comprehensive and complex phenomena such as (national) income are observed reasonably accurately and published without much delay. Exports and imports do not, however, provide the same sort of information about the condition of the economy of DEEs. Actually exports often do not provide a meaningful picture of the impact of a crisis. A decline in domestic demand may, for example, induce firms to find new markets abroad and, if policy makers respond with devaluation, one would expect exports to increase in the aftermath of a financial crisis. This is all the more true as policy makers typically opt for an export led growth strategy to get out of a crisis situation. Resources are thus often re-allocated towards the export sector in order to ensure that hard currency can be earned, for example, in order to be able to meet international debt obligations. Exports thus actually may tend to grow during and after financial crises. From a political economy perspective the perception may be relevant that imports entail an outflow of hard currency. Thus policy makers might not be inclined to come to the aid of importing firms (unless the imports are crucial for the exporting industry). Payment risk is especially relevant for the importer who will experience a rise in transaction costs, for example, because letters of credit or even full payment in advance is required. The reduction in effective demand that is a consequence of a financial crisis directly translates into a reduced import volume. Finally, in a scenario that involves a depreciation of the currency, the price of imports will rise and thus exert a negative influence on the volume of imports. All in all the impact of a financial crisis should be expected to be most visible and unambiguous in the development of the volume of imports.

Where does the crisis hit?
Figure 1 analyses the decline in the volume of imports in a cross-country setting for a group of 45 countries over the years 2007 to 2009. This group of countries covers the OECD and the major DEEs (China is not included because the data are insufficiently comparable). The Figure compares the peak and the trough of the import cycle over this period. The figure first of all illustrates the large variation in country experiences. The Netherlands registers one of the smallest import contractions (of about -11 per cent); the largest contractions of some - 45 per cent occur in Belarus and Venezuela. Importantly, the figure relates this decline to the level of development (which is approximated by the income per head in US dollars). The dotted regression line indicates that lower income per head is associated with stronger contraction of the volume of imports. The observation that the DEEs (have to) reduce their import expenditures to a much larger extent suggests that they are hit harder by the crisis than the richer countries. Of course this is not a direct observation but the finding that many DEEs are adversely hit by the crisis is corroborated by other more advanced techniques such as the World Bank’s applied microsimulation models which also show that these macroeconomic effects trickle down to the (new) poor and especially a middle income group of ‘crisis vulnerable’ with substantial poverty and distributional effects and potentially important effects on long term growth. It is also important to note that imports in the National Accounts are subtracted in order to arrive at Gross Domestic Product. A contraction of imports will thus paradoxically influence GDP upwardly. This may make the National Account figures look more positively than the actual ‘underlying’ development of consumption, investment and net government expenditure. The upshot is that a recovery of GDP may be less sustainable than expected.
All in all, the important conclusion of this article is that the developing and emerging economies particularly have experienced very substantial declines in import volumes. The implication is that these countries must have been hit relatively hard. Importantly, the contraction of imports will limit their prospects over the medium term, because development requires imports of capital goods, raw materials, intermediate goods and essential consumer goods. The contraction of imports may thus act as a future drain on development and the influence of the crisis will go 
beyond the direct economic impact, for example because health care has to be cut down. The World Bank/IMF Global Monitoring Report 2010 The MDGs after the Crisis analyses the impact of decelerating growth on human development indicators finding that life expectancy at birth on average declines by 10 per cent as infant and child mortality increase by 50 to 75 per cent respectively. Against this background the development of ODA is even more disappointing.
Imports provide a good indication of crisis impact
Development Co-operation Report 2009 estimated that the underlying trend growth rate of the volume of aid needed to increase to 11 per cent per year in order to achieve the Millennium goals. The results in 2009 were, however, disappointing as the amount of aid increased by 0.7 per cent only. Importantly this is not the result of increased spending but of exchange rate movements that contribute more than 4 percentage points. Actually total ODA in current prices and at current exchange rates decreased from US$122 billion in 2008 to 119 billion in 2008 (actually 12 OECD countries reduced ODA). UNCTAD’s recent Global investment trends monitor, declined in 2009 by 35 per cent and 39 per cent, respectively. Export volumes also showed substantial declines. According to the World trade monitor (compiled by CPB Netherlands Bureau of Economic Policy Analysis) DEEs real exports at the start of 2010 were some 12 per cent below their previous high (the peak of the trade cycle is in 2008). Experiences at the regional level showed a lot of variation. Asia definitely did better, but exports in Latin America had decreased by 19 per cent and the volume of exports in the Middle East and Africa was even 25 per cent below the previous peak level (the trade cycle for the latter region appears to follow a double dip pattern).

Wednesday, 24 November 2010

One is not enough. Understanding world trade collapse. Luncheon presentation at the Peterson Institute, Monday November, 29, 2010

The world trade collapse that started in October 2008 and reduced global trade by some twenty per cent in only a few months time remains one of the most puzzling phenomena of the last decade. In mid-2009 a consensus amonst trade economists appeared to have emerged. The concensus can be summarized in two ways. Many economists argue that the trade collapse was a demand shock multiplied by a composition effect (the 2009 edited volume by Richard Baldwin is an example). The other view in the profession (of which the WTO in 2009 is an example) is that the trade collapse was caused by protectionism, lacking trade finance and the fragmentation of production in international value chains (the latter incidentally is seen to be a driver of composition effects).

My problem with both representations of the consensus is that they are based on empirical analyses of post Second World War data only. Economists typically do not include the Black Swan of the 1930s in their analysis. This would seem to be simply inappropriate for the analysis of world trade collapse essentially because it is thus implicitly treated as a unique event and actually ‘such events can only be explained historically as they defy the laws of economics’.

In order to fix this methodological problem I study the drivers of import collapse in a data set that comprises 27 economies in the 1930s and 45 economies in the 2000s using variables for which comparable data are available for both periods. Both the demand shock and the composition effect are comparatively speaking much less important in the recent trade collapse than in the 1930s. Institutional factors are important for both periods (this is a factor that is completely lacking in the mainstream narrative). In particular I find that the decline of imports is stronger in centralized autocratic economies which offers circumstantial evidence for my theory that a shock in trade uncertainty is a major cause of the strength and speed of the trade collapse.

Finally I find that the share of manufacturing was an important determinant of the collapse of imports in the 1930s, nut much less so. This is a remarkable and exciting finding given the profession’s early and outspoken conviction that supply chains were a (if not the) driver of the extraordinary trade developments in late 2008 and early 2009. The correlation between international value chain activity and globalization in the period before the trade collapse (that constitutes the basis for the main stream narrative on the impact of value chain activity on openness and international trade) may be genuine but requires a different interpretation. Globalization is a firm driven process and fragmentation of production according to the available evidence has been associated with an increase in the world’s trade-to-GDP-ratio. The underlying mechanism may, however, be quite different from the purely mechanical statistical relationship that relates to the different modes of measurement regarding GDP (value added) and trade (turn-over). Value chain interaction may bread trust amongst participating firms because of the repeated-buy character of the transactions and/or have external effects (such as demonstration effects, learning effects or network effects) which support globalization. If this is the case, there is no reason why this role should be asymmetrical (positive in upswings and negative in downturns) as assumed by the dominant narrative.

This has important implications both for the analysis and for policy advice, in particular the idea of stabilizing economies by means or a reorientation towards domestic production. In contrast my findings imply that additional efforts are in order to increase trust in the trading system in particular by a firm commitment to the multilateral approach.

Friday, 19 November 2010

Ref.: Ms. No. IEEP-D-10-00038
International Value Chains and The World Trade Collapse: A Cross-Country Perspective
International Economics and Economic Policy

Dear prof dr van bergeijk,

Reviewer's comments on your work have now been received. You will see that it is advising against publication of your work. Therefore I must reject it.

For your guidance, I append the reviewer's comments below.

Thank you for giving us the opportunity to consider your work.

Yours sincerely

Thomas Domeratzki
Editorial Assistant
International Economics and Economic Policy

Reviewer's comments:

Reviewer: Summary

The paper "International Value Chains and the World Trade Collapse: A Cross Country Perspective" examines the role of vertical value chains in the trade collapse of 2008/09. Using a cross-country estimation, the decrease in imports between 2008-2009 is regressed on the degree of vertical value chains (as measured by (i) manufacturing products in total imports and (ii) an index capturing the degree of vertical specialization) as well as some control variables. In focusing on imports as endogenous variable, the paper differs from traditional contributions that primarily investigate the effects on export flows. Also, the results differ from the recent literature with respect to causality: The author argues that vertical fragmentation is not amplifying but rather dampening the trade crunch of 2008-2009. The subject of the paper is interesting and, as it refers to the actual trade collapse, it also fits into a growing part of the international trade literature. However, the role
of vertical value chains in the trade collapse is not well established in the paper.

Major Points

I. The paper is not well motivated. Apart from the fact that the analysis of trade in 2008-2009 attracts interest by its own, the paper does not present any motivation on why to study this issue. Moreover, the introduction does not contain a specific literature review that discusses the current state of contributions in the field. To be sure, the author mentions some papers, however, without discussing any results. He solely mentions econometric techniques that are used by other contributions in order to motivate that there is a lack of cross section analysis that he tries to fill with this paper. The absence of a detailed discussion of previous results raises several questions, especially with respect to the economic crisis, where there is a time structure intrinsic to the phenomenon. E.g.: why should there be the need to abstract from the time series? Furthermore, as the results in this paper contradict with the current view on the role of the sourcing mode for the
strength and duration of the crisis, the introduction should include a discussion on causalities and not exclusively on econometric technology. On this account, the reader expects a survey as regards the state of the art, the results thus far, what drove these results (i.e. causalities) and why (the true) causalities might differ from those presented in the literature thus far.

II. The author mentions that the data is preliminary and will be "updated and revised in the next quarters". Since the contribution of the paper is solely an empirical one, it is disputable if one should employ a preliminary dataset, especially if, in addition, key results conflict with the state of the literature.

III. Since the results in this contribution claim the exact opposite of what we know from the recent literature, the author may want to extend the analysis in a number of ways, in particular:

1. First, why do other contributions arrive at the result that international value chains amplify the trade crisis? What is the story and the theoretical reasoning behind those findings?

2. Second, the reader misses sort of a formal model or at least a discussion on how the results attained in this contribution can be explained. Why does vertical fragmentation dampen rather than amplify the trade crisis here?

3. The econometric estimation is characterized by some problems that need to be addressed:
3.1 There should be a serious endogeneity problem between import flows and vertical fragmentation (or manufacturing inputs as a share of imports) that at least requires discussion in the paper. Even if the author is able to tackle this problem by focusing on exogenous variables that are observed before the time of the crisis, the point should be discussed, whether this time structure is suitable for solving the endogeneity problem, or whether there should be other instruments used in order to deal with this problem.
3.2 Is it really possible to examine the role of fragmentation in the trade collapse when having access to data that covers only such a short period of time?
3.3 The index of vertical specialization that is used is not defined neither is it explained. The author draws on data from an OECD report without explaining how the index is defined and what the index is capturing. Since "vertical specialization" is by no means a clearly defined phenomenon (see the extensive literature on this and the variety of measures that has been used thus far), it is necessary to explain exactly what is used as main exogenous variable.

4. Since the analysis is fragile, conclusions and policy recommendations provided in section 5 need to be framed more carefully.

Minor Points

I. The text and the writing is somewhat sloppy (lots of typos etc.)

II. In the regression equations on p.8, there is the constant missing. In addition, there are no subscripts indicating countries, changing rates, levels, etc. Generally speaking, the author may want to be more exact when presenting formulas and math.

III. The usage of the exogenous control variables could be expanded. Maybe the author could explain why not to use the GDP variable in regression 2?

IV. Presenting the t statistic additional to the p value is useless in the discussion of the regression results. When explaining results, it is common practice to talk about significance levels of 1, 5 or 10 percent and not the inverse levels of 90, 95, or 99 percent.

Friday, 1 October 2010

SSRN

Your paper, "Let’s Assume the WTO is Wrong: 6 plus 1 Hypotheses for the World Trade Collapse", was recently listed on SSRN's Top Ten download list for International Trade eJournal. As of 09/30/2010, your paper has been downloaded 62 times. You may view the abstract and download statistics at http://papers.ssrn.com/abstract=1656537.
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Wednesday, 29 September 2010

TRADE CONTRACTION PATTERN AFTER CRISIS:

Z Yamin, H Haoshen - TRADE CONTRACTION PATTERN AFTER CRISIS:  Trade and Finance Association Conference Papers, 2010

Even without concrete and observable trade conflicts, the implied uncertainty about trading possibilities will influence the extent of specialization and the pattern of specialization as well (p. 5)

Congress of Diplomats

you've got that wrong

Message do 2 sep 2010 8:48

From: "Richard Baldwin"

To: Peter van Bergeijk

Subject: Your paper on trade collapse.

Attachments: Attach0.html 8K
Hi,
Your paper asserts: "the main stream narrative that links the strength and speed of the world trade collapse in 2008-9 to (i) lacking trade finance, (ii) international value chains and (iii) ‘murky’ protectionism."
I think you’ve got that wrong. See http://www.voxeu.org/index.php?q=node/4297 for what is the mainstream explanation. It was a demand shock multiplied by a composition effect.


Richard Baldwin

Marrewijk, C. van, 2009, ‘Spatial diffusion of technology and the trade collapse’

At the end of his inaugural address, Charles van Marrewijk at Utrecht University pointed out that a better titel would have been COLLAPSING TRADE FLOWS: THE SUPPLY CHAIN MYTH. Indeed. Van Marrewijk uncovers similar patterns as On the brink of globalization where his study is extensively quoted. Van Marrewijk uses the Grubel-Loydd index for intra-industry trade and studies both exports and imports Van Marrewijk analyzes the depth, the duration and the inclination (steepness) of the trade cycle from peak to trough. In addition he uses four different ways to define peak and trough, namely the original raw data, a 5-month centered average, and deviations from trend based on either of these two series. In no case does Van Marrewijk find the hypothesized positive correlation between on the one hand, the share of intra-industry trade and on the other hand, the depth, duration and inclination of export and/or import trade declines.

The inaugural address was published in Dutch in the ooggetuigen (eywitnesses) section of Economisch Statistische Berichten - Ooggetuigen: De mythe van de aanbodketen. C. van Marrewijk JAARGANG 95 NR. 4590