EC361 Lecture Introduction Slides

World trade
• 5 facts about world trade:

• Since 1960, world trade has become a much larger part of the world
economy.
World Imports/GDP
World trade
• Since 1960, world trade has become a much larger part of the world
economy.
• Almost 60% of trade is manufacturing goods
2005 world trade
Changing composition of developing-country
exports
• Countries that depend on metal or mineral exports are typically quite poor, with the dominance of these sectors generally a tell-tale sign of
a lack of any kind of sophisticated industrial base. There are, however, exceptions. Australia enjoys one of the world's highest living
standards, notwithstanding a global trade balance driven by coal and other minerals, while copper-oriented Chile is Latin America's richest
country. The black-colored oil exporters are an interestingly diverse group. The richest countries in the world — places like Norway and
Qatar — fall into this category, but so does middle-income Russia and desperately poor Chad.
World trade
• Since 1960, world trade has become a much larger part of the world economy
• International supply chains boost trade
World trade
• 90% of world trade is by sea
World trade
• 90% of world trade is by sea
• Technology has greatly reduced trade costs
The gravity model
The gravity model
• Xni are exports from n to i

• Yi and Yn are exporter and importer GDPs
• Dni is distance from i to n
• G is a constant
Disdier and Head (2008) : “The Puzzling Persistence of the
Distance Effect on Bilateral Trade”
The gravity model
The gravity model
The border effect
• Trade between countries is harder than trade between regions within
a country
• Economists have coined how harder it is “the border effect”, as it
involves crossing an international border
• The border effect is the empirical regularity that trade is much higher
within countries than across country borders
The border effect
• Why do borders reduce trade?
• Tariffs
• Administrative barriers (docs)
• Currency exchange
• Cultural barriers
• …?
• The border effect can also be thought of as a home bias, i.e. a
preference for home goods over foreign ones
International Trade (EC 361.02)
Gravity Model
21.09.2016
Who trades with whom?
Observation: Volume of world trade has reached 16 trillion $ (2008). All

countries participate in international trade to some extent.
Question: How to make sense of the trade patterns and the data? How to
categorize information and detect the fundamental features?
Aim: We need a parsimonous model which can summarize/highlight the main
determinants of trade (a descriptive model)?
US Trade
Figure: Top ten trading partners
Canada Canada
China China
Mexico Mexico
Japan Japan
Germany Germany
United Kingdom Rep. of Korea
Rep. of Korea United Kingdom
France France
Saudi Arabia Brazil
Venezuela Saudi Arabia
0 200 400 600 0 200 400 600

US Trade 2008 (in billion $'s) US Trade 2014 (in billion $'s)
US-EU Trade
.4
Germany
.3
Share of US Trade (2006)
.2
France
Netherlands Italy
.1
Belgium
Sweden Spain
Denmark
0
0 .1 .2 .3 .4
Share of GDP (2006)
TR Trade
Figure: Top ten trading partners
Russian Federation Germany
Germany Russian Federation
Italy China
China Italy
USA USA
France United Kingdom
United Kingdom France
Iran Iran
United Arab Emirates Iraq
Spain Spain
0 10 20 30 40 0 10 20 30 40
TR Trade 2008 (in billion $'s) TR Trade 2014 (in billion $'s)
Gravity model
A reduced-form model of trade (A probabilistic framework by Jan Tinbergen,

1962):
GDPi GDPj
Tij = A (0.1)
Dij
where Tij is the volume of trade (=imports+exports) and Dij is the distance
between country i and j .
Trade openness: Total trade scaled by the size of the economy:
P
Tij
j6=i
(0.2)
GDPi
Gravity model - Data US
Gravity model - Data TR
Use of Gravity Model
Statement: The IT revolution and the drastic decline in the transportation

costs have made the world more connected.
Observation:
Figure: Distance eect over time (Head and Mayer, 2010)

Market Potential I
Figure: Top ten countries
BEL
NLD
CHE
AUT
DEU
FRA
IRL
CZE
CAN
DNK
0 2.0e+07 4.0e+07 6.0e+07

Foreign Market Potential (Redding and Venables, 2004)
Market Potential II
Figure: TR vs US
TUR USA
1500000
Foreign Market Potential (RV2004)
1000000
500000
0
1960 1970 1980 1990 2000 1960 1970 1980 1990 2000
Year
Graphs by group(iso)
Market Potential III
Figure: MP and Development

Trade Barriers
• Language
• Shared colonial history
• Common legal code
• Trade aggreements (WTO, NAFTA)
• Political distance: Trade declines when disputes over international issues
(Mityakov, Tang, and Tsui; 2013)
• Border eects: Canadian provinces trade more with other provinces
compared to the US states with a similar size and distance
GDPia GDPjb
Tij = A (0.3)
f (Dij , X )
ij
Summary
• Gravity is a powerful framework to describe trade ows

• Trade is positively related to the economic size of the trading partner and
negatively related to the economic/political distance
• Economic geography predicted by the gravity model can be helpful in
explaining cross-country income dierences
International Trade (EC 361.02)
Ricardian View
26.09.2016
Patterns of trade
Observations: There are visible dierences across countries in the types of

goods and services that they export.
Questions:
• Are these dierences systematic?
• Can we relate the variety of exports of a country to its economic
fundamentals (productivity, endowments, institutions, history...)?
Aims: We need to
• look closer at the trade data,
• construct models of trade to rationalize our observations and to formulate
new testable hypotheses on the patterns of trade.
World trade
Figure: Two waves of globalization

The rise in trade I
Trade at the sectoral Level I
Trade at the sectoral Level II
.6
.4
.2
0 AG MA
share
MI SE
.6
.4
.2
0
1980 1990 2000 2010 1980 1990 2000 2010

Year
Graphs by Indicator_code
The rise of services
Alan Blinder:
In the future.., the key distinction for international trade... will be
between services that can be delivered electronically over long
distances with little or no degradation of quality, and those that
cannot.
International division of labor
Traditional North-South dichotomy: primary goods vs. manufactured goods
International division of labor II
Traditional North-South dichotomy: Is it important?

The Prebisch-Singer Hypothesis suggests that over the long run the
price of primary goods declines relative to manufactured goods, and
terms of trade of developing countries deteriorate.

International division of labor III
International division of labor II
Traditional North-South dichotomy: Is it still important?

International division of labor III
Traditional North-South dichotomy: Is it still important?
GERMANY TURKEY
.2
High-Tech Share of Merchandise Exports
.1
0
1960 1980 2000 20201960 1980 2000 2020

year
Graphs by group(countrycode)

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World trade

• 5 facts about world trade:

• Xni are exports from n to i

Observation: Volume of world trade has reached 16 trillion $ (2008). All

Figure: Top ten trading partners

United Kingdom Rep. of Korea

Rep. of Korea United Kingdom

Saudi Arabia Brazil

Venezuela Saudi Arabia

0 200 400 600 0 200 400 600

Figure: Top ten trading partners

Russian Federation Germany

Germany Russian Federation

France United Kingdom

United Kingdom France

United Arab Emirates Iraq

A reduced-form model of trade (A probabilistic framework by Jan Tinbergen,

Statement: The IT revolution and the drastic decline in the transportation

Figure: Distance eect over time (Head and Mayer, 2010)

Figure: Top ten countries

0 2.0e+07 4.0e+07 6.0e+07

Figure: MP and Development

• Gravity is a powerful framework to describe trade ows

Observations: There are visible dierences across countries in the types of

Figure: Two waves of globalization

1980 1990 2000 2010 1980 1990 2000 2010

between services that can be delivered electronically over long

distances with little or no degradation of quality, and those that

Traditional North-South dichotomy: Is it important?

price of primary goods declines relative to manufactured goods, and

terms of trade of developing countries deteriorate.

Traditional North-South dichotomy: Is it still important?

Traditional North-South dichotomy: Is it still important?

1960 1980 2000 20201960 1980 2000 2020

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Figure: Distance eect over time (Head and Mayer, 2010)

• Gravity is a powerful framework to describe trade ows

Observations: There are visible dierences across countries in the types of