The spectacular increase in hoarding of international reserves by emerging markets since the East Asian crisis has been one of the defining features of global imbalances. This column explores lessons from the crisis regarding alternatives to massive hoarding. It says that the crisis validates the need for external debt management policy and that the presence of fire-sale externalities associated with deleveraging, optimal external borrowing-tax cum international reserves hoarding-subsidy reduces the cost and the scale of hoarding international reserves.
The “pollution haven” view asserts that globalisation draws industries to countries with lax environmental regulation. This column presents evidence that that the major polluting industries are not very footloose and that changes in emissions through the relocation of activities are relatively small. The growth of trade itself, however, is likely to contribute to growing emissions associated with transport.
Current US fiscal policy is likely to produce current account deficits rising to $1 trillion by 2015 and $3 trillion by 2025; net foreign debt would reach $15 trillion by 2020, taking the US’s foreign-debt-to-GDP ratio far beyond the threshold that normally triggers currency crises and forces painful economic retrenchment. To avoid catastrophic risks stemming from soaring foreign debt, the US needs a plan for long-run fiscal sustainability.
International supply chains – or vertical linkages – are a leading contender for explaining why the great trade collapse was so great. This chapter presents research aimed at quantifying the consequences of intermediate goods import linkages for the transmission of shocks and declines in trade. It highlights the importance of vertical linkages and specific sectoral shocks in accounting for the sudden, severe, and synchronised collapse of global trade in the aftermath of the Lehman debacle.
Japan’s trade was particularly hard hit by the great trade collapse. This chapter marshals evidence for the idea that Japan’s extensive involvement in international supply chains was a major reason for its larger and faster than average trade collapse.
Goods trade has collapsed; services trade hasn’t. The likely reasons are that demand for many traded services is less cyclical and their production is less dependent on finance. As services trade seems inherently less affected by crises, services should play a more prominent role in developing countries’ diversification strategies.
US trade has experienced an unexpectedly large drop – seven standard deviations more than that predicted by theory. We evaluate three leading hypotheses on its causes: the vertical linkages effect, the compositional effect, and the credit effect. Using highly disaggregated US trade and production data, we show that between 50% and 100% of the drop is due to a “compositional effect”, i.e. that trade fell systematically more in sectors that also experienced larger domestic output reductions. The trade drop was also particularly concentrated in sectors marked by strong vertical linkages. We find no evidence that US trade was significantly hindered by trade credit problems.
Was the global credit crunch a cause of the great trade collapse? This chapter addresses this question by drawing on evidence from 23 historical banking crises. It shows that export growth was particularly slow in sectors that were particularly reliant on external finance (e.g. electric machinery). The findings suggest how credit problems may have played a role in today’s global crisis. The historical findings show that negative demand shocks have amplified negative effects on exports when teamed with a banking crisis, with this interaction being especially important in durable goods industries. The same combination of factors (financial constraints coupled with a demand slump) – but this time it is operating on a vastly larger scale – may have been central to the great trade collapse.
Japanese exports were hit particularly hard by the crisis. This chapter shows how tumbling US import demand hurt Japanese exports both directly and via indirect exports of goods assembled in China for the US market (the so-called “trade triad”). An investigation into the extensive and intensive margins during Japan’s recent trade collapse shows that most adjustment occurred in existing trade relationships; there is very little evidence of deeper harm to Japan’s export capability via damage to its international supply chain. That means the ongoing recovery of the US economy should produce an especially speedy revival of Japanese exports.
Drawing upon the latest data on protectionism from the Global Trade Alert database, this chapter reports the extent to which governments have altered the discrimination against foreign commercial interests during the sharp global downturn and nascent recovery of the past twelve months. Tariff increases have been relatively rare – contemporary discriminatory policies come in murkier forms, such as financial bailouts.
Previous global trade collapses provide insight into why trade has dropped so dramatically this time – and the future of trade and global imbalances. The findings suggest that the real trade drop in 2009 is likely to exceed 15%, but it should rebound very rapidly. Global imbalances have also moderated in crises, but this tends to be temporary unless the downturn alters investment attitudes and/or government policies. Today, governments should use the transition to install policies that will ensure that imbalances do not revert to pre-crisis trends – policies to encourage saving in the US and prevent an overvalued dollar, and policies to stimulate spending in China and other parts of Asia and prevent undervalued currencies
By some measures, the trade collapse that started in late 2008 has shifted into a rapid recovery phase. The simplest explanation that fits the facts is that trade has followed the sectoral composition of the recession. The recession has been hardest on heavy manufacturing – machinery, vehicles, and related raw materials. This has translated into a deep manufacturing recession and an even deeper drop in trade. US and Chinese data show that these sectors are far more important in the composition of trade than they are in the composition of GDP.
Africa has been hard hit; its export revenue collapsed as both prices and volumes of commodity exports dived, and capital inflows shrunk. National budgets were hit as tariff revenue fell with imports and overseas development assistance slumped. Developed countries’ responses to the crisis have fed a growing backlash against the Washington Consensus, but major reversals of reforms seem unlikely. African policy makers tend to see the crisis as a temporary setback and are adopting coping strategies that reflect that view.
Today’s great trade collapse has brought world trade to a point that is still substantially below the corresponding period during the Great Depression. The collapse, however, seems to be turning around along with the economic recovery. This chapter draws two critical Great-Depression lessons for today. First, policy makers must ensure that the recovery continues; many of the worst political and economic-policy transformations only came after the Great Depression was into its second and third years. Second, recent research shows that severe exchange rate misalignments teamed with rising unemployment led to much of the 1930s protectionism. The issue of the renminbi peg to the dollar is one that needs to be confronted sooner rather than later, for everyone's sake.
Collapsing trade worsened the crisis, but trade’s revival could do much to shore up prospects for a sustained upturn. Unlike many stimulus measures, reviving the Doha Round and strengthening the open multilateral system could be achieved with little, if any, fiscal cost. It is also essential to ‘rebalance’ the global economy. Successful emerging markets and other countries with large current account surpluses will have to shift gradually toward more reliance on domestic demand and less on export growth.
Re-balancing global trade will be difficult, generating substantial protectionist pressures. To manage these pressures, governments must maintain domestic political support for an open world economy. This in turn requires flexible responses to national political pressures. Rigid, unrealistic insistence on exemplary behaviour will be less fruitful than efforts at modest, feasible cooperation on trade policies. Above all, governments singly and jointly need to address the underlying macroeconomic causes of the imbalances to prevent serious trade confrontations.
One of the nations hit hardest by the great trade collapse is Mexico– its trade falling over 40% in the six months following September 2008. Mexico’s imports and exports, however, have both recovered remarkably in recent months and are now three-quarters of the way back to peak values. This chapter argues that Mexico’s close engagement with the US industrial supply chain accounts for these unusually sharp movements.
If the current “shock” to US trade is similar to previous ones, most of the decline in exports and imports stems from a decline in sales of previously exported goods rather than a decline in the number of products exported. To the extent that is true, trade will bounce back relatively quickly once conditions improve. The alternative view is that the severe credit crunch produced a higher-than-usual share of harder-to-reverse firm exits – potentially dampening the speed of recovery. Even if this did occur, history suggests that it will be concentrated amongst small firms which account for only a small fraction of US exports; US multinationals dominate US trade and these firms have the wherewithal to weather the credit crunch. Should the dollar continue to decline, US firms will broaden the range of products exported and the range of markets reached, putting further downward pressure on the trade deficit.
The precise role of supply chains in the trade collapse is an unsettled matter. This chapter marshals evidence behind the notion that trade within international supply chains has been more resilient than other trade during the great trade collapse.
Sir Partha Dasgupta of the University of Cambridge talks to Romesh Vaitilingam about why some countries are rich and others are poor. He argues that trust is the fundamental building block of societies – without it, there can be no basis for cooperation, which in turn leads to progress and economic development. The interview was recorded in Bristol, where he was delivering the Royal Economic Society’s annual public lecture in November 2009.
Currency unions strip national governments of a macroeconomic policy instrument. What do they get in return? This column says the European Economic and Monetary Union has eliminated incentives for competitive devaluations and enhanced inflation credibility. But monetary union may necessitate fiscal coordination and discipline.
World trade experienced a sudden, severe, and synchronised collapse in late 2008 – the sharpest in recorded history and deepest since WWII. This ebook – written for the world's trade ministers gathering for the WTO's Trade Ministerial in Geneva – presents the economics profession's received wisdom on the collapse. Two dozen chapters, written by leading economists from across the globe, summarise the latest research on the causes of the collapse as well as its consequences and the prospects for recovery. According to the emerging consensus, the collapse was caused by the sudden, severe and globally synchronised postponement of purchases, especially of durable consumer and investment goods (and their parts and components). The impact was amplified by “compositional” and “synchronicity” effects in which international supply chains played a central role.
Detailed firm-level data on French exporters suggests most of the trade collapse occurred in exporters’ volumes rather than the number of exporters. Small exporters suffered similarly to their larger counterparts. There is clear evidence that the impact was greatest on firms in sectors that rely most heavily on external finance. Thus, the crisis may not have long-lasting effects on aggregate export capacity – the reservoir of small and promising firms has not been decimated– but firms may reorganise to reduce vulnerability to external financing.
India’s trade collapsed alongside global trade, although its decline started earlier due to a concerted effort by the Reserve Bank of India to cool the economy in 2008. Demand-side factors seem to be the primary culprits. Looking forward, India should overhaul its export promotion mechanisms, shifting the focus to the binding constraints – physical infrastructure problems, skill shortages, procedural complexities, and inadequate access to commercial bank credit, especially for the small and medium exporters.
The global crisis has been accompanied by an unprecedented collapse in world trade driven by an unusual and globally synchronised drop in demand. That decline has rapidly improved global imbalances, since the gap between exports and imports ineluctably falls at the same pace as the underlying export and import flows. As import and export growth resume, large global imbalances will return unless both surplus and deficit economies undergo structural changes.
Trade has declined massively during the crisis. This chapter assesses the relative roles of falling demand and rising trade costs in explaining the collapse and compares it to the Great Depression. Surprisingly, the authors calculate that the increase in trade costs today is as large as in 1929 despite the absence of any modern protectionism resembling Smoot-Hawley. If their calculations turn out to be correct, reviving global demand alone will be insufficient to revive world trade.
World trade experienced a sudden, severe and synchronised collapse in late 2008 – the sharpest in recorded history and deepest since WWII. VoxEU today posts a new Ebook – written for the world's trade ministers gathering for the WTO's Trade Ministerial in Geneva – that presents the economics profession's received wisdom on the collapse. Two dozen chapters, written by leading economists from across the planet, summarise the latest research on the causes of the collapse as well as the consequences and prospects for recovery.
The giant and global drop in trade was concurrent with an equally colossal and global credit crunch. Did the financial market turmoil directly disrupt trade by reducing the availability of trade financing? This chapter marshals the best available evidence on the importance of trade-credit financing as a cause of the crisis. Surveys of participants indicate that trade-credit problems were the number two cause of the trade collapse (after demand). Europe and North America experienced bigger problems early in the crisis, but by mid-2009, the problem was mainly felt in Eastern Europe and Africa. The scant direct evidence, however, suggests that the drop in trade credit was shallower than the drop in trade. Policy responses to shore up trade credit were early and massive; these may have dampened credit problems.
The US was critical to the global trade collapse and will be pivotal to the sustainability of the ongoing trade revival. This chapter documents the US role in the great trade collapse. It warns that the US trade recovery is relatively fragile, as it started late, has been dependent on a one-time stimulus for autos, and has not stimulated demand for imported capital goods as much as consumer goods. It is thus unclear whether US import demand can support other economies’ recoveries without a significant improvement in US business confidence.
The trade collapse hit Africa hard, particularly its exporters of natural resources and manufactured goods. As commodity prices have started to recover, so has African trade. This chapter recommends concluding the Doha round of WTO negotiations and investing in Aid for Trade initiatives to make the revival sustainable and support developing economies’ long-term interests.
Using monthly trade data for OECD nations, this chapter first highlights the very exceptional nature of the great trade collapse. It then presents evidence to suggest that the magnitude of the global decline reflects greater synchronisation of trade flow declines across countries.
How will proposed increases in energy R&D funding affect other types of R&D spending? This column provides evidence that should dampen concerns about crowding out – increased R&D in response to policies designed to enhance clean-energy innovation most likely comes at the expense of R&D in dirty-energy technologies.
Standard DSGE models do not include the possibility of default. This column says that makes them useless for analysing financial crises. It proposes explicitly incorporating default and money into the microfoundations of DSGE models so as to offer a new framework for monetary and regulatory policy analysis.
Sharing of information is critical to scientific progress, but scientists have private incentive to avoid disclosing research. This column analyses the benefits and costs of sharing, both one-to-one and with the general scientific community, and assesses how government funding and scholarly competition shape sharing decisions.
The Federal Reserve Open Market Committee has been criticised for making forecasts that are inferior to Federal Reserve staff forecasts. This column argues that FOMC forecasts are worst-case scenarios used to inform policy decisions, rather than best estimates of future events. It says that FOMC forecasts are a rational response to doubts about the staff’s model.
Many rich countries have chosen to outsource public services. This column discusses the costs and benefits of such outsourcing policies and identifies when they improve welfare.
The UK needs to address its budget deficit. This column, introducing a new CEPR Policy Insight, argues against cuts in government contributions to the tuition chargeable by universities, warning that they would make the UK poorer, economically and culturally. It suggests instead additional deferred fees that graduates can pay later in their career when their income allows it.
The UK’s early estimate of GDP growth for the third quarter of 2009 still shows negative growth with a reading of -0.4%. This column combines the quarterly releases of GDP with timely survey data to form a “now-cast” of quarterly GDP growth. It says that the UK has likely exited the recession already, estimating positive growth of 0.15%.
Climate change will have widespread negative effects of uncertain magnitude. But this column argues that climate change is not humanity’s biggest challenge and needs to be solved without impeding economic development. It calls for a measured policy of greenhouse gas emission reduction.
Economics lacks an anchored understanding of the nature of the reality that economics is supposed to illuminate. This column, which introduces a new CEPR Policy Insight, says that instability of leverage, connectivity, and the potential instability of the price level have all been neglected in stable-with-frictions macro theory. Technical innovations will not bring real progress as long as “stability-with-frictions” remains the ruling paradigm. Meanwhile, governments are not prepared to face another crisis.
Almost all economies are party to preferential trade schemes. But how much are they “giving away” or “receiving” in preferential access? This column presents a compact representation of effective market access and applies it to the proposed ASEAN-EU trade agreement.
There is some evidence that democracies enjoy better economic growth. How do elections, a core component of democracy, impact economic policy? This says that free and fair elections in developing countries improve economic policy by disciplining governments. But infrequent or uncompetitive elections may actually make things worse.
What is the geographical distribution of CO2 emissions? This column identifies the Earth’s “polluting centre of gravity” since 1970. It is heading east faster than GDP, which suggests that Asian production is getting more carbon-intensive.
Patrick Low, chief economist at the World Trade Organization (WTO), talks to Romesh Vaitilingam about the case for ‘critical mass’ decision-making as an element of the WTO’s overall decision rules in the future, once the Doha Round has been completed. The interview was recorded in Geneva at the inaugural Thinking Ahead on International Trade conference in September 2009.
Ideology, institutions, political, and accepted economic wisdom shape economic policy choices. This column explores how political ideologies and academic conclusions shaped US policymakers’ responses to the global financial crisis. It says that forecasting macroeconomic developments necessarily involves forecasting the role of such beliefs.
The extraordinary assumptions of macroeconomic models have left the outside world perplexed about what economists have been doing during the last few decades. This column contrasts the incongruous rational expectations top-down model with a bottom-up model where no individual is capable of understanding the full complexity of a market system. The bottom-up model creates correlations in beliefs that generate waves of optimism and pessimism. The latter produce endogenous business cycles akin to the Keynesian “animal spirits”.
Will the economic recovery be U-, V-, W-, or L-shaped? This column warns that recoveries from recessions caused by financial crises are slower than others, due to stressed credit conditions that persist even after output begins to recover. It thus recommends policies aimed at recapitalising financial institutions, resolving distressed financial assets, ensuring adequate provision of liquidity, and expediting bankruptcy proceedings.
There is one important source of information on the effectiveness of monetary and fiscal stimulus in an environment of near-zero interest rates, dysfunctional banking systems and heightened risk aversion that has not been fully exploited: the 1930s. This column gathers data on growth, budgets and central bank policy rates for 27 countries covering the period 1925-39 and shows that where fiscal policy was tried, it was effective.
Today’s global crisis has been compared to the Great Depression in terms of world output, trade, and stock market value. To extend the comparison, this column proposes a new, historically comparable measure of economic uncertainty. The evolution of uncertainty in this crisis has been much less dramatic than in the 1930s.
Can euro-area governments cushion the impact of the crisis without damaging market perceptions of their fiscal sustainability? This column suggests that euro-area sovereign spreads have typically reflected a common factor that mimics global risk repricing, not country-specific solvency concerns. But in the last year, market sentiments seem to have shifted to concerns about fragile national financial sectors and future debt dynamics.
How should governments respond to sudden failure of the financial system? This column says that it is neither credible nor desirable to refuse to assist the private sector in financial crises. It makes the case for massive provision of credible public insurance and guarantees to financial transactions and balance sheets – a financial defibrillator to respond to sudden financial arrest.
The Copenhagen Summit could be crucial for the future of climate change. This column says negotiators should aim to agree on a global emissions target for 2050, the rapid deployment of a satellite system to measure country emissions, a worldwide cap-and-trade system, governance providing incentives to join the agreement, and a subsidiarity principle with permits allocated domestically by the countries themselves. The negotiation for 2015 could then focus on the worldwide allocation of free permits.
Global imbalances are shrinking at a fabulous rate. This column argues that these improvements are mostly illusory – the transitory side-effect of the greatest trade collapse the world has ever seen. A global recovery will almost surely return the US, Germany, China and others to their old paths.
How will economic theory emerge from the global crisis? This column says that representative agent models and the efficient markets hypothesis are assumptions that have persisted too long in the face of empirical evidence. It argues that economic theory is due for an overhaul but fears that economists will resist such change.
Will the faster-than-expected recovery from the global crisis cause governments to avoid much-needed reforms? This column says it shouldn’t, as important developing countries can now drive reforms via the G20. It suggests how Asia could leverage its growing economic weight into more effective G20 participation.
Can we blame financial globalisation for the severity of the current crisis? This column says that financial integration spread the negative banking shock that originated in the US across countries, thereby making the US better off at others’ expense.
Global food price volatility is costly. This column argues that most food price spikes are driven by major policy shifts, such as tariffs and subsidies, which result in harmful tit-for tat behaviour. It makes the case for completing the Doha round to further restrain WTO members’ unilateral actions.
Resource-rich countries are often cursed by corruption and governance problems. This column shows that the natural resource curse burdens non-democracies, but countries with better democratic institutions are not corrupted by such endowments. For governments accountable to their citizens, resources can be a blessing.
Domingo Cavallo, former minister of economy and minister of foreign affairs in Argentina, talks to Romesh Vaitilingam about the dangers of a future resurgence in world inflation, as economies that have adopted very expansionary monetary and fiscal policies in response to the crisis are tempted to ‘inflate away the debt’. The interview was recorded at the Global Economic Symposium in Schleswig-Holstein in September 2009.
Liquidity and default are inseparable. Liquidity problems fuel defaults and vice versa. This column discusses the shortcomings of current regulatory proposals to address liquidity and default. It says that regulators must address “systemic markets”, not just systemic institutions, and need informative measures of financial stability.
A merger reduces competition if it leads direct competitors to increase prices or reduce innovation without attracting endogenous entry. This is what is expected in the market for enterprise database systems if the merger between Oracle and Sun goes through. The European Commission is correctly investigating on the anti-competitive effects of this merger
Output and trade flows both collapsed during the crisis, but the causal relationship is not clear. This column analyses trade flows at the sectoral level and finds that international trade transmits shocks across countries. Such spillovers raise the importance of fiscal policy coordination.
The distance puzzle is the surprising finding that the volume of trade has become increasingly sensitive to distance. This column shows that low-income countries, which increasingly trade with geographically closer partners, drive the finding. This regionalisation of trade for low-income countries may reflect progress – or problems.
How do offshoring firms reshape their domestic workforce? This column, using evidence from German multinationals, shows a positive correlation between offshoring and the firm’s proportion of highly educated workers. Offshoring firms have relatively more domestic jobs involving non-routine and interactive tasks. But offshoring is far from the only explanation for the shift towards more educated employees carrying out more advanced tasks.
Twenty years after the fall of the Berlin wall, Germany’s political unification has succeeded. This column argues that its economic unification has not – East German growth has been very disappointing and pulled down the economy as a whole. It blames policies that raised East German wages above market levels.
The fall of the Berlin Wall 20 years ago created a number of "natural experiments" that economists have exploited to advance our understanding of fundamental issues. This column reviews the use of German data to examine the surprisingly large impact that international borders have in geographically dampening buying and selling patterns. Its results show that the biggest barriers to trade stem from economic fundamentals rather than technological and political barriers. Infrastructure and tariffs can come done quickly; it takes at least a generation to tear down the wall in our minds.
East Germany has done better than other ex-communist states, but it has not caught up to West Germany. There were two key mistakes – using politically expedient but highly distortionary payroll taxes to fund social buy-outs and trying to resist agglomeration effects by spreading money thinly across every town and village. This column argues that closing the gap will be tough, since convergence will come only when East Germany has the same level of social, institutional, business, and marketing infrastructure.
There is a post-crisis consensus on the need to address systemic liquidity risk and its role in propagating turmoil. This column, which accompanies the release of a new CEPR Policy Insight, refines the implementation details of a new macro-prudential tool – liquidity risk charges – to discourage systemic risk creation by banks.
Most evidence says that emerging economies remain coupled to global growth. Does that threaten their economic resilience? This column says that emerging economies’ growth is more linked to Chinese growth than that of G7 economies, suggesting that their performance is rooted in well-founded, long-term economic trends.
Governments are bitterly divided about how advanced and developing economies should share the burdens of aggressive climate change mitigation. This column suggests a “do no harm” principle by which developing countries would be enabled to reduce their cost of mitigation to zero until they have eliminated abject poverty.
The timing of the subprime crisis that became the global crisis is well known. Its impact on the foreign exchange markets has been much less discussed. This column fills that void. Its findings suggest that foreign exchange portfolio managers could have protected their portfolio by an appropriate risk control strategy using market stress indicators.
Douglas Almond of Columbia University talks to Romesh Vaitilingam about his research with Bhashkar Mazumder on women who are pregnant during the Islamic holy month of Ramadan and the impact of fasting on their children – in terms of birth weight and the likelihood of being a boy or girl, as well as later life health outcomes. The interview was recorded at the Centre for Market and Public Organisation in Bristol (UK) in October 2009.
The crisis is putting downward pressure on development assistance. This column, which presents the 2009 European Report on Development, says that now is precisely the time that EU support to fragile states is most crucial, so that such countries can respond to the crisis without abandoning necessary long-term reforms and improvements.
Global trade contracted quickly and severely during the crisis. This column, using data on French firms, shows that both small and large exporters were similarly hurt, but the impact of the crisis varied across industries. Intermediate goods, equipment, and the automotive industry were hit hardest. Sectors more dependent on external finance suffered larger export drops.
Little is known about the basic economic principles of open-air markets and bazaars, which have existed for centuries. This column explores the fundamental underpinnings of such markets. While exchange prices approach the prediction of competitive market equilibrium theory, such markets are ripe for price manipulation.
Policymakers and macroeconomists often remind us that banking crises are nothing new. This column, based on recent papers by Columbia professor Charles Calomiris, looks at the long-term record of banking crises and draws lessons for today.
In December 2009, government guarantees on the issuance of bank bonds will close to new issuance in many EU countries. This column argues that the guarantees have been effective and should be extended into 2010, despite improved market conditions and bank profitability. In doing so, governments should correct the schemes for some distortionary effects and develop a careful exit strategy.
The volume of world trade has plummeted with the global crisis. This column says that high-quality imports are more responsive to income changes than low-quality imports. This explains why world trade value fell faster during the crisis than world trade volume, which fell faster than GDP.