INTER-ECON_Chap_2_WORLD_TRADE__1_

WORLD TRADE Overview

• Global economic interactions through exchanges of goods and services between countries.

OBJECTIVES

After studying this chapter, you will be able to:

• Describe how the value of trade between countries correlates with the size of their economies.

• Discuss how geographic factors, such as distance and borders, impact trade.

• Explain historical fluctuations in the share of international production traded and the two ages of globalization.

• Describe the evolution of international trade in terms of the types of goods and services exchanged.

WHO TRADES WITH WHOM?

• Figure 2-1 details U.S. trade in 2019 with its 15 major trading partners.

• Factors influencing trade volume include:

  • Economic size (GDP) of trading partners.

  • Geographic proximity.

SIZE MATTERS: THE GRAVITY MODEL

• The Gravity Model posits that:

  • Countries with larger economies tend to trade more.

  • This correlation is particularly evident in U.S. trade with Europe, particularly with Germany, the UK, and France.

• GDP measurement reflects total economic output, forming a strong empirical link between GDP and trade volume.

EMPIRICAL EVIDENCE

• Figure 2-2 illustrates relationships between GDP and trade.

  • Clustering of points around the 45-degree line indicates a strong correlation.

  • For example, Germany represents 20% of Western European GDP, correlating with 24% of U.S. trade.

• Sweden, with a smaller GDP share (3.2%), reflects lower trade volume (2.3%).

TRADE EQUATION

• General equation predicting trade volume: [ T_{ij} = A \cdot Y_i \cdot Y_j / D_{ij} ]

  • T_{ij} = trade value between countries i and j,

  • Y_i & Y_j = respective GDPs,

  • D_{ij} = distance between countries.

• Highlights the positive correlation between GDP size and trade and the negative impact of distance.

INFLUENCE OF DISTANCE

• Direct relationship:

  • Higher GDP correlates with higher trade volume.

  • Increased distance inversely affects trade volume.

• Distance costs become less significant over time due to advances in technology and transportation.

ADVANCED GRAVITY MODEL

• A more generalized model accounts for:

  • Size of GDPs.

  • Distance.

  • Adjusts factors a, b, and c to best fit data.

LARGE ECONOMIES AND TRADE

• Large economies tend to:

  • Spend more on imports.

  • Attract larger shares of international spending.

LIMITATIONS TO TRADE

• Actual international trade is influenced by:

  • Domestic income spending tendencies (e.g., the U.S. and EU).

  • Barriers created by distance and trade agreements.

TRADE WITH NEIGHBORS

• Canada and Mexico, despite smaller economies, trade significantly more with the U.S. due to:

  • Proximity.

  • Trade agreements (NAFTA/USMCA).

• The gravity model shows a negative distance effect, with estimates indicating a 0.7%-1% drop in trade per 1% increase in distance.

IMPEDIMENTS TO TRADE

• Continental and historical ties make trade easier among neighboring countries.

• Example: High volumes of trade with Canada and Mexico compared to geographically closer but less engaged European partners.

CHANGING PATTERNS OF WORLD TRADE

• Trade patterns have evolved significantly over time.

  • Factors influencing these changes include:

    • Driven by technological advancements in transportation and communications.

    • The role of the internet and modern jet transportation.

• The shift from earlier trade models to present day dynamics, with new emerging markets and digital services.

TWO WAVES OF GLOBALIZATION

1. First Wave (1820-1914): Advances in transportation (railroads, steamships) and communication (telegraph).

2. Second Wave (1960-Present): Post-WWII globalization marked by container shipping and the Internet.

COMPOSITION OF WORLD TRADE

• Manufactured goods represent a substantial share of trade today compared to primary goods or agricultural products historically.

• Countries exporting significant amounts of manufactured products post-1970s have changed trade dynamics, especially among developing countries.

SERVICE OFFSHORING

• The practice of relocating business functions internationally, often for cost efficiency.

• Key distinction between goods that can be physically transported and services that can be digitally delivered, emphasizing a shift in trade focus.

ROLE OF ECONOMIC THEORIES

• Establishing classical economic principles that remain relevant amidst changing trade dynamics.

• The Gravity Model continues to be a primary tool for analyzing trade behavior.

SUMMARY

• Gravity Model shows the relationship between GDP and trade volume, while highlighting the impact of distance.

• Current international trade levels are high relative to GDP sizes, influenced by lowering transport and communication costs.

• The modern landscape of trade has shifted from raw materials to manufactured goods and increasingly to service-oriented exports.

EXAMPLES OF GRAVITY MODEL IN PRACTICE

• Situations illustrating how barriers like tariffs, cultural ties, and geographic proximity can significantly influence trade beyond economic predictions.