EC315 MT Week 1 - Introduction, facts and concepts
The Big Questions
Trade theory tries to answer a number of classic questions:
- What determines the pattern of trade? (Who trades with whom, what and how much?)
- What are the effects of international trade on economic welfare?
- What are the effects of trade policies?
- How do domestic policies interact with trade and trade policies?
The emphasis in international trade analysis is on real transactions rather than asset flows or exchange rate
movements.
General equilibrium effects are often central to the analysis (i.e. not just on one particular market, but the general
impact across the economy).
Is There a Lot of International Trade?
- Looking at the value of exported goods as a share of
GDP, we see it dipped quite heavily during the inter-war
period
- During the financial crisis, we saw a sharp drop, and we
are now experiencing something similar (but even
sharper) with the pandemic
o It’s fairly well known that trade crises are quite
often even deeper than financial crises, which
affects GDP, and thus trade as a fraction of GDP
changes much more during crises
- However, more generally, we see that since WWII,
world trade flows have grown substantially faster than
world output
Trends in Globalization
Let’s look broadly at the overall trade patterns in modern economic history:
- Note: we’re going to see some
migration & FDI throughout the
course, but broadly speaking, this is
much less understood than trade →
much easier to think in terms of
physical products moving across
borders as it’s easier to measure
- As the world has changed and
services have become much more
important, our data tools have not
quite kept pace to be able to record those transactions
- So, what we think is really happening is these numbers are possibly picking up a much smaller part of the
story (typically picking up trade in goods) → not measuring trade in services very well, and certainly not
picking up many other new forms of trade such as digital services (which we still don’t know how to record
very well)
- With that caveat in mind, what we still see broadly is that we live in a much more globalized world today
- It wasn’t as though the world has never been globalized → the world was already globalized in the early
1900s (before and during inter-war period, trade growth was still significant but not spectacular, although
population and GDP growth were fairly low)
- More specifically, since the post-war period, we have seen much more integration
,Possible explanations for trade growth:
- Technological: improvements in transportation and communication technologies
- Political: trade liberalization
o Helped by formation of World Trade Organisation (WTO), which led to a substantial reduction in
trade policy barriers and to an opening up of trade across borders
Merchandize Trade
GDP Shares
in the UK, US and Germany:
- 1913: high trade to GDP ratios, well integrated
- In the middle, it starts to fall
- Then, we see an increase, making up for the inter-war period
What is Different Between the Late 20th Century and the 19th Century?
Although on aggregate it may seem similar, there is a difference in what is being traded between the early 19th
century and the late 20th century:
- Merchandize exports as a share of tradeables output (agriculture, mining and manufacturing) have increased
substantially
- Importance of manufacturing as opposed to agriculture and raw materials trade
- Importance of intermediate inputs (goods and services you buy from other businesses in order to make a
product yourself), as measured by the share of capital goods
- Related idea of slicing up the value-added chain and fragmentation of production (e.g. not just the final
product, but the components that make up the product)
- Importance of intra-industry trade as opposed to inter-industry trade
o Intra-industry trade: similar goods and services belonging to the same industry are both imported
and exported
o Inter-industry trade: trade of goods and services belonging to different industries
- Existence of supertrading economies
- The emergence of low-wage manufacturing exports
Trends
Let’s look in somewhat more detail at some aspects of current trade patterns.
Commodity Composition of Trade
- Higher-end manufacturing, services and digital products have
become the dominant traded products
- Although as mentioned before, the services numbers aren’t
measured accurately
Geographic Pattern of Trade
- Rise of large developing economies (e.g. China
and India)
- The bulk of trade, even with this rise, is still
between developed countries and other
developed countries, or developed countries on
one side of the transaction
- In that sense, we’re not very different from how
things used to be earlier, with the rise of China
and India not displacing those patterns
, - However, the largest exporters have changed, with China now the
largest exporter; South Korea is also a big exporter now
- These countries have shown how globalization can play a role in
development, as well as in raising income growth across the world (but
where does this growth go? → inequality?)
- Looking at regional shares however, we still see North America and
Europe continue to be the dominant players in international trade
- One of the reasons is they have a lot of trade within the regions
(e.g. NA to NA, EU to EU, NA to EU etc.)
Inter- vs Intra-industry Trade
What are the goods and services being exported and imported?
- Earlier, we’d tend to see inter-industry trade, with the developing countries exporting agricultural and low-
level manufacturing goods to developed countries, and developed countries sending back higher-level
manufacturing goods
- This changed around the 80s when a deeper dive into the trade data saw that there was a lot more intra-
industry trade
- We now see a large fraction of trade (about half of it) is patterns of intra-industry trade
o One reason behind this phenomenon is economies of scale (we’ll see this later)
The relative importance of intra-industry trade is measured by the Gruber-Lloyd Index (i.e. the fraction of total trade
that is accounted for by intra-industry trade):
|𝐸𝑥𝑝𝑔 −𝐼𝑚𝑝𝑔 |
𝐺𝐿𝑔 = 1 − (for good 𝑔)
𝐸𝑥𝑝𝑔 +𝐼𝑚𝑝𝑔
- No intra-industry trade: 𝐼𝑚𝑝𝑔 = 0 so 𝐺𝐿𝑔 = 0
- No inter-industry trade: 𝐸𝑥𝑝𝑔 = 𝐼𝑚𝑝𝑔 so 𝐺𝐿𝑔 = 1
The graph shows estimates of the Gruber-Lloyd index for total
intra-industry trade in manufactured goods for selected countries
- We see places like Africa have very small G-L indices (i.e.
intra-industry trade is small)
o Instead, they mostly have an inter-industry trade
flavour (e.g. ship out cocoa, buy back cars)
- If we look at more developed countries such as North
America and Europe, we see very high G-L indices (i.e. a
lot of intra-industry trade e.g. ship out cars, buy back cars)
, Task Trade
- Next, we’ll look at the new forms of trade
- Earlier, much of trade was about sending final
products back and forth across borders
- It was mostly dependent on your production
capacity and capabilities, as well as what you
specialized in
- Now, however, there’s a different view
- Countries are now integrating with each other’s value
chains (e.g. buying car components from Belgium,
manufacturing them in Sunderland, and then shipping
them to countries such as Greece)
- Production itself is now fragmented
- If we look at the percentage of imported inputs in
total inputs, we see it has been rising
- The graph shows how it has evolved over time
- The amount of trade coming in as intermediates and
not final goods has increased massively
Capital Flows
- The mobility of capital across borders, particularly investment capital (i.e. FDI going across borders), has
increased since the 1970s around the world
- If we break this down, we see a big chunk of continues to be between developed countries, although there’s
been the rise of China and India
Transport Costs
- Freight costs have fallen (about halved) since the mid-
1970s, which is a massive change in transport costs
- This wasn’t just through lower shipping costs, but the
rise of air transport and international communication
The Big Questions
Trade theory tries to answer a number of classic questions:
- What determines the pattern of trade? (Who trades with whom, what and how much?)
- What are the effects of international trade on economic welfare?
- What are the effects of trade policies?
- How do domestic policies interact with trade and trade policies?
The emphasis in international trade analysis is on real transactions rather than asset flows or exchange rate
movements.
General equilibrium effects are often central to the analysis (i.e. not just on one particular market, but the general
impact across the economy).
Is There a Lot of International Trade?
- Looking at the value of exported goods as a share of
GDP, we see it dipped quite heavily during the inter-war
period
- During the financial crisis, we saw a sharp drop, and we
are now experiencing something similar (but even
sharper) with the pandemic
o It’s fairly well known that trade crises are quite
often even deeper than financial crises, which
affects GDP, and thus trade as a fraction of GDP
changes much more during crises
- However, more generally, we see that since WWII,
world trade flows have grown substantially faster than
world output
Trends in Globalization
Let’s look broadly at the overall trade patterns in modern economic history:
- Note: we’re going to see some
migration & FDI throughout the
course, but broadly speaking, this is
much less understood than trade →
much easier to think in terms of
physical products moving across
borders as it’s easier to measure
- As the world has changed and
services have become much more
important, our data tools have not
quite kept pace to be able to record those transactions
- So, what we think is really happening is these numbers are possibly picking up a much smaller part of the
story (typically picking up trade in goods) → not measuring trade in services very well, and certainly not
picking up many other new forms of trade such as digital services (which we still don’t know how to record
very well)
- With that caveat in mind, what we still see broadly is that we live in a much more globalized world today
- It wasn’t as though the world has never been globalized → the world was already globalized in the early
1900s (before and during inter-war period, trade growth was still significant but not spectacular, although
population and GDP growth were fairly low)
- More specifically, since the post-war period, we have seen much more integration
,Possible explanations for trade growth:
- Technological: improvements in transportation and communication technologies
- Political: trade liberalization
o Helped by formation of World Trade Organisation (WTO), which led to a substantial reduction in
trade policy barriers and to an opening up of trade across borders
Merchandize Trade
GDP Shares
in the UK, US and Germany:
- 1913: high trade to GDP ratios, well integrated
- In the middle, it starts to fall
- Then, we see an increase, making up for the inter-war period
What is Different Between the Late 20th Century and the 19th Century?
Although on aggregate it may seem similar, there is a difference in what is being traded between the early 19th
century and the late 20th century:
- Merchandize exports as a share of tradeables output (agriculture, mining and manufacturing) have increased
substantially
- Importance of manufacturing as opposed to agriculture and raw materials trade
- Importance of intermediate inputs (goods and services you buy from other businesses in order to make a
product yourself), as measured by the share of capital goods
- Related idea of slicing up the value-added chain and fragmentation of production (e.g. not just the final
product, but the components that make up the product)
- Importance of intra-industry trade as opposed to inter-industry trade
o Intra-industry trade: similar goods and services belonging to the same industry are both imported
and exported
o Inter-industry trade: trade of goods and services belonging to different industries
- Existence of supertrading economies
- The emergence of low-wage manufacturing exports
Trends
Let’s look in somewhat more detail at some aspects of current trade patterns.
Commodity Composition of Trade
- Higher-end manufacturing, services and digital products have
become the dominant traded products
- Although as mentioned before, the services numbers aren’t
measured accurately
Geographic Pattern of Trade
- Rise of large developing economies (e.g. China
and India)
- The bulk of trade, even with this rise, is still
between developed countries and other
developed countries, or developed countries on
one side of the transaction
- In that sense, we’re not very different from how
things used to be earlier, with the rise of China
and India not displacing those patterns
, - However, the largest exporters have changed, with China now the
largest exporter; South Korea is also a big exporter now
- These countries have shown how globalization can play a role in
development, as well as in raising income growth across the world (but
where does this growth go? → inequality?)
- Looking at regional shares however, we still see North America and
Europe continue to be the dominant players in international trade
- One of the reasons is they have a lot of trade within the regions
(e.g. NA to NA, EU to EU, NA to EU etc.)
Inter- vs Intra-industry Trade
What are the goods and services being exported and imported?
- Earlier, we’d tend to see inter-industry trade, with the developing countries exporting agricultural and low-
level manufacturing goods to developed countries, and developed countries sending back higher-level
manufacturing goods
- This changed around the 80s when a deeper dive into the trade data saw that there was a lot more intra-
industry trade
- We now see a large fraction of trade (about half of it) is patterns of intra-industry trade
o One reason behind this phenomenon is economies of scale (we’ll see this later)
The relative importance of intra-industry trade is measured by the Gruber-Lloyd Index (i.e. the fraction of total trade
that is accounted for by intra-industry trade):
|𝐸𝑥𝑝𝑔 −𝐼𝑚𝑝𝑔 |
𝐺𝐿𝑔 = 1 − (for good 𝑔)
𝐸𝑥𝑝𝑔 +𝐼𝑚𝑝𝑔
- No intra-industry trade: 𝐼𝑚𝑝𝑔 = 0 so 𝐺𝐿𝑔 = 0
- No inter-industry trade: 𝐸𝑥𝑝𝑔 = 𝐼𝑚𝑝𝑔 so 𝐺𝐿𝑔 = 1
The graph shows estimates of the Gruber-Lloyd index for total
intra-industry trade in manufactured goods for selected countries
- We see places like Africa have very small G-L indices (i.e.
intra-industry trade is small)
o Instead, they mostly have an inter-industry trade
flavour (e.g. ship out cocoa, buy back cars)
- If we look at more developed countries such as North
America and Europe, we see very high G-L indices (i.e. a
lot of intra-industry trade e.g. ship out cars, buy back cars)
, Task Trade
- Next, we’ll look at the new forms of trade
- Earlier, much of trade was about sending final
products back and forth across borders
- It was mostly dependent on your production
capacity and capabilities, as well as what you
specialized in
- Now, however, there’s a different view
- Countries are now integrating with each other’s value
chains (e.g. buying car components from Belgium,
manufacturing them in Sunderland, and then shipping
them to countries such as Greece)
- Production itself is now fragmented
- If we look at the percentage of imported inputs in
total inputs, we see it has been rising
- The graph shows how it has evolved over time
- The amount of trade coming in as intermediates and
not final goods has increased massively
Capital Flows
- The mobility of capital across borders, particularly investment capital (i.e. FDI going across borders), has
increased since the 1970s around the world
- If we break this down, we see a big chunk of continues to be between developed countries, although there’s
been the rise of China and India
Transport Costs
- Freight costs have fallen (about halved) since the mid-
1970s, which is a massive change in transport costs
- This wasn’t just through lower shipping costs, but the
rise of air transport and international communication
