Why there's growth in trade

by Tim Whitehead

Why is it that your job seems to depend more and more upon global economic conditions and less and less on what’s happening in your own community? There was a time, beyond living memories, when a good year was determined by a good harvest. Now, Asian meltdowns affect interest rates, exchange rate fluctuations trigger layoffs or hirings, and decisions by the U.S. Federal Reserve shake or bolster consumer confidence here. Why? The simple answer is that the world economy is more closely knit than ever before. Over the last half century, the size of the world’s economy grew six fold, but the volume of world trade in goods increased 20 fold. And the growth in the trade of manufactured goods was almost twice as much again. But that simple answer doesn’t really help because it leads to another question: Why has world trade grown so quickly? And on this question – perhaps the most significant economic question of the post-war era-economists have typically produced more guesses than definitive answers. Multiple-Choice Question Three possible explanations for the explosive growth in world trade lead the pack: 1.Transportation costs have fallen. When it costs less to export a widget, more widgets will be exported. As well, if silicon chips replace steel, the shipping costs become an almost negligible barrier to trade. 2.The world’s economies have opened themselves up. Canada used to impose heavy tariffs on hair dryers – though none were made in this country. France welcomed imports of Japanese VCRs, provided that they came through one particular customs office on the French border with Germany, staffed by one customs officer who, on official orders, took very, very long lunch breaks. When those barriers were reduced or eliminated, more Canadians could accept that ‘the wet head is dead’ and more French could watch Jerry Lewis movies in the privacy of their own homes. Multiply that trade liberalization across many goods and many economies and the impact is enormous. 3.Because the income disparity between countries has narrowed – more precisely, other industrialized countries have narrowed their gaps with the United States – products produced for one country have become more marketable in other countries. The, ahem, classic example is Coca-Cola. Coke doesn’t sell well in a dirt-poor country for an obvious reason. Let the average income in that country rise, however, and the ‘real thing’ can become an imported thing. Plausible explanations each but, until a recent study, economists had no way of determining the relative importance of them. “The growth of world trade: tariffs, transport costs, and income similarity” by Scott Baier and Jeffrey Bergstrand of the University of Notre Dame produces some answers. The two researchers looked at the growth in international trade, using data from the IMF on bilateral trade between 16 developed countries from the late 1950s to the late 1980s. (They chose the endpoint to eliminate the influence of the phase-in of the Canada-U.S. Free Trade Agreement.) The Best Answer The winner – the most important explanation for the explosion in international exports and imports – was trade liberalization. The authors’ estimates attribute about two-thirds of the growth in international trade to the reduction in tariff and non-tariff barriers. Falling transportation costs explained only about a third of it. Income convergence – the narrowing of income differentials between trading partners – accounted for almost none of the growth in world trade. Because the study deliberately excludes the impact of the FTA and NAFTA, it probably understates the influence of trade liberalization in the globalization of Canada’s economy. Since the late 1980s, the endpoint for the Baier-Bergstrand study, Canada’s GDP is up by 50 per cent, but the value of our exports to the United States has grown 150 per cent. Much of that could be attributed directly to freer trade within North America – the liberalization that Baier and Bergstrand highlight. Of course, while the Baier-Bergstrand findings may answer one long-standing question, they leave untouched the question whether people like their more open economy. Most economists believe that trade liberalization has improved Canada’s economy, but virtually everyone would agree that it has wedded our economic lives more closely to what happens elsewhere in the world, for better or worse.

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