Macroeconomic determinants of international trade.
Rose, Andrew K.
Introduction
Much research on international trade patterns focuses on deep
primitive causes of trade, such as differences in national factor
endowments, preferences, or technologies. In much of my recent research
in the area, I examine less traditional causes of trade flows. In
particular, I've tended to focus mostly on the macroeconomic determinants and consequences of trade.
How much does Monetary Union Stimulate Trade?
A number of countries in the Americas and Europe have engaged in
monetary unions of late. This is usually to the chagrin of academic
economists who point out that joining a monetary union means giving up
the tool of independent monetary policy that can be used to smooth
idiosyncratic business cycles. This cost seems high, and there are
others. Where are the benefits of currency union?
Perhaps currency union brings the benefit of higher international
trade within the union. If there's a single issue that economists
agree on, it's that trade should be as free and unfettered as
possible. And, two countries with different monies are separated by a
monetary barrier to trade, otherwise known as the exchange rate. That
barrier might be small if exchange rate costs are small or easy to
hedge; but the barrier might be large. After all, the one thing we know
about exchange rates is that they tend to change, usually in
unpredictable ways. Quantifying the impact of currency unions and
exchange rate uncertainty on trade is thus an empirical exercise of
importance.
In a 1999 paper I quantified the impact of currency union on trade
and found it to be remarkably large. (1) In particular, I estimated that
two countries sharing a common currency will trade over three times as
much as an otherwise comparable pair of countries, holding other things
equal. This effect is large--implausibly large-but my extensive
sensitivity analysis simply couldn't reduce it substantially.
My research was based on a model that I have tended to use quite a
bit for much of my work in international trade: the bilateral
"gravity" model of trade. The gravity model has enjoyed a
resurgence of use in the last decade, because it has solid theoretical
foundations and turns in an admirable empirical performance. Stripped to
its essence, the gravity model states that trade between a pair of
countries is inversely proportional to the distance between them, and is
proportional to their combined economic mass (usually proxied by GDP).
(2) The model fits the data well and produces plausible coefficient
estimates that tend to be similar across different studies and authors,
an unusual combination in economics.
One of the issues with the gravity model is that it is
intrinsically cross-sectional, relying on variation across pairs of
countries. That's a disadvantage for inherently time-series
questions such as: "what is the effect on trade of leaving or
joining a currency union?" To address such important questions,
Reuven Glick and I gathered a dataset covering over 200 countries and 50
years. (3) This enabled us to use a variety of conventional panel data
techniques, including the "fixed-effects" estimator that uses
only time-series variation within a pair of countries. We found that the
impact of leaving a currency union was still large; countries that
dissolve currency unions see their trade shrink dramatically, ceteris
paribus. Assuming symmetry, a pair of countries joining a common
currency experiences a near doubling of trade.
My estimates of the effect of currency unions on trade are high,
implausibly so to many researchers. Consequently, a number of critiques
of my work have started to circulate. I have tried to list and respond
individually to many of these criticisms on my website. Still, it is
interesting to summarize the mass of this research as a whole. One way
to do this objectively is by using "meta-analysis": a set of
tools that can quantitatively survey the literature. The key task is to
construct a vector of estimates (of the effect of currency unions on
trade), one estimate from each study. There are currently 34 studies in
the area, each differing in a number of dimensions. This set of (34)
estimates can then be summarized and linked to the features of the
underlying studies. The meta-analysis shows that the literature as a
whole finds a statistically significant and economically large effect of
currency unions on trade, averaging around 60 percent, but with
considerable variation. (4)
Suppose that a currency union does indeed cause trade to rise.
Should we care? Jeffrey, Frankel and I investigate that question by
linking the effect of currency unions on trade to the effect of trade on
output. We find that the indirect effects of currency unions on output
can be large, and manifested through trade promotion rather than more
stable macroeconomic policies. (5) For instance, we estimate that the
potential long-run output stimulus from accession to the Euro could be
over 20 percent for countries like Hungary, Poland, Sweden, and the
United Kingdom. Even if our estimates are off by a factor of five,
policymakers ignore such effects at their peril.
There is also an interesting, self-fulfilling feedback loop
that's possible. Suppose that a currency union tends to stimulate
trade, and that more trade in turn tends to make business cycles more
synchronized. In this case, entering into a currency union lowers the
main cost of the currency union, namely foregone monetary independence.
A pair of countries with business cycles that are dissimilar ex ante
(making currency union look costly) might have more coherent business
cycles ex post because the increase in trade stimulated by the currency
union tends to synchronize business cycles. Frankel and I discovered
that this is more than an academic point. (6) Even after controlling for
endogeneity, we found strong evidence that two countries with more
international trade tend to have more synchronized business cycles.
Does the Multilateral Trade System Have Strong Effects on Trade?
Most economists now agree that "institutions" are
important determinants of the standard of living, growth rates, and
other key macroeconomic phenomena. Typically these institutions are
measured as the presence (or lack) of domestic political, legal, or
financial constraints on the ability of economic agents to engage in
harmful activities. It is interesting to exploit the existence of
comparable international institutions. For instance, researchers have
studied how the activities of the International Monetary Fund (IMF) and
the World Bank affect growth, inflation, poverty; inequality, and the
environment.
One interesting gap in the literature concerns the role of the
World Trade Organization (WTO) and its predecessor, the General
Agreement on Tariffs and Trade (GATT). The success (or lack thereof) of
IMF and World Bank programs has been studied a great deal by researchers
both inside and outside the beltway. But there has been essentially no
comparable research on the effects of the WTO. This is odd but perhaps
understandable. Economists like free trade, and accordingly the
institution in charge of freeing trade is by far the most popular and
least controversial of the Bretton Woods trinity, (IMF, World Bank, and
GATT/WTO). Still, some evaluation of an important institution like the
WTO is better than none. This is especially true since the WTO has
lately (if unfairly) acquired a notorious reputation as a result of
disastrous meetings in Seattle and Cancun.
In a 2002 paper, I examine the performance of the GATT/WTO in terms
of its own mandate of trade promotion. (7) At any point in time, there
are countries both inside and outside the system; similarly, many
countries that began outside the system subsequently" have acceded.
Thus, there is both time series and cross-sectional variation available
to estimate the effect of membership on trade. Using a gravity- approach
and aggregate data, I find that countries that are formal members of the
GATT/WTO seem to engage in amounts of trade that are similar to those of
countries outside the system. Accession to the system seems to raise
trade, but by an amount that is economically small compared with
intuition, the effects of regional trade agreements, and the hype
surrounding WTO negotiations. But extensive robustness checks left few
signs that members of the GATT/WTO had substantially higher trade than
outsiders.
This negative result seems hard to believe initially; after all,
one of the most well-known facts in international economics is that
trade consistently grows faster than income. That might be the result of
dropping transportation costs. Still, it seems hard to believe that the
multilateral trade system is irrelevant, especially the GATT-sponsored
eight successful "rounds" of multilateral trade negotiations.
Then again, perhaps not. "Most Favored Nation" status
might seem like the great prize of GATT/WTO membership. But it turns out
that MFN status typically is given away freely to most countries outside
the GATT. (8) Further, many believe that the GATT historically made few
demands on most countries in terms of trade liberalization, since most
entrants to the system were developing countries eligible for special
and differential treatment (a synonym for most "special and
differential treatment" is "protectionism"). That is,
many developing countries joined the GATT without substantial changes in
their trade policies.
I pursue this idea in another paper. (9) In particular, I use
almost 70 quantitative measures of trade policy--all that I could find
in the literature--to ask whether membership inside the GATT/WTO system
is associated with less protectionism. The answer is a deafening
silence; there is essentially no substantive evidence that WTO members
have systematically lower or less widespread tariffs, non-tariff
barriers, and so forth. Membership in the WTO seems to have few
privileges in the form of higher trade, but it comes with few
responsibilities in terms of more liberal trade policy.
The WTO is an institution that was designed by its creators to be
toothless; it cannot use sticks since it does not hold any carrots (such
as conditional IMF loans). And perhaps the WTO is not even interested in
higher trade, only greater trade stability. I also investigate the
hypothesis that membership in the system makes trade more predictable.
(10) Unfortunately for the WTO, both bilateral and multilateral evidence
reveal few consistent signs that membership in the GATT/WTO reduces the
volatility of trade flows.
Why do Countries Repay Sovereign Debts?
One of the ongoing mysteries in international finance is why
investors are willing to export capital, especially to governments of
developing countries. After all, sovereigns frequently default on their
debts, and have done so for hundreds of years, in many countries. When a
sovereign (such as Argentina) defaults, there are few sanctions that can
be applied by foreigners (such as Americans). Debtors like Argentina
don't have much collateral that Americans can seize, even in
principle. Invading to enforce debt contracts is unthinkable. And there
are so many serial defaulters that it's hard to take any concerns
about reputation seriously, given the prevalence of repeat offences. Why
then does Argentina ever service its debts? And equivalently, why do
Americans ever lend to Argentina?
One thing Americans can do to encourage repayment is threaten to
damage Argentina's trade in the case of default. This threat might
be explicit, in the forms of tariffs and trade sanctions intended to
deter default. But such threats are rarely observed. More likely, any
threat is implicit; country risk insurance rates rise in the case of
default and trade credit tends to shrink. For whatever reason, debtors
like Argentina might fear being cut off from the fruits of international
trade following default. Is this fear reasonable? Does trade typically
shrink following sovereign default?
I answer this question using another large panel data set,
including the dates of over 200 "Paris Club" debt
renegotiations to measure default. (11) Controlling for a host of other
factors, it turns out that trade does indeed shrink after default. The
shrinkage in trade only amounts to 8 percent a year, but it's a
highly persistent effect, lasting over a decade. That is, countries have
at least one solid reason to repay their debts, because they risk losing
out on international trade in the case of default.
If default tends to lower trade, then it stands to reason that
creditors should lend more to countries with which they have closer
trade links. That way the linkage between default and trade can be as
tight as possible. Mark Spiegel and I provide a simple theoretical model
of this idea and test it empirically. (12) We use Bank of International
Settlements data on international banking claims between 20 creditor and
149 debtor countries between 1986 and 1999 and show that there is a
robust positive link between bilateral trade and lending patterns. That
is, debtors tend to borrow more from creditors with whom they share more
international trade.
(1) A. K. Rose, "One Money, One Market: Estimating the Effect
of Common Currencies on Trade," NBER Working Paper No. 7432,
December 1999, and in Economic Policy, 2000.
(2) For more discussion, see J. E. Anderson and E. van Wincoop,
"Gravity with Gravitas: A Solution to the Border Puzzle," NBER
Working Paper No. 8079, January 2001.
(3) R. Glick and A. K. Rose, "Does a Currency Union Affect
Trade? The Time Series Evidence," NBER Working Paper No. 8396, July
2001.
(4) A. K. Rose, "A Meta-Analysis of the Effects of Common
Currencies on International Trade," NBER Working Paper No. 10373,
March 2004.
(5) J.A. Frankel and A. K Rose, "Estimating the Effect of
Currency Union on Trade and Output," NBER Working Paper No. 7857,
August 2000.
(6) J. A. Frankel and A. K Rose, "The Endogeneity of the
Optimum Currency Area Criteria," NBER Working Paper No. 5700,
August 1996, and The Economic Journal, 108 (449) (July 1998), pp.
1009-25.
(7) A. K. Rose, "Do We Really Know that the WTO Increases
Trade?" NBER Working Paper No. 9273, October 2002.
(8) For instance, as of August 2004, only six countries
(Afghanistan, Cuba, Laos, North Korea, and Serbia-Montenegro, and
Vietnam) did not have normal trade relations (the equivalent of MEN
status) with the United States, even though many countries were not in
the WTO (Russia and Saudi Arabia being perhaps the most prominent
non-members); see http://www.itds.treas.gov/mfn.html.
(9) A. K. Rose, "Do WTO Members have More Liberal Trade
Policy?" NBER Working Paper No. 9347, November 2002.
(10) A. K. Rose, "Does the WTO Make Trade More Stable?"
NBER Working Paper No. 10207, January 2004.
(11) A. K. Rose, "One Reason Counties Pay Their Debts."
Renegotiation and International Trade," NBER Working Paper No.
8853, March 2002.
(12) A. K. Rose and M. M. Spiegel, "A Gravity Model of
Sovereign Lending: Trade, Default, and Credit," NBER Working Paper
No. 9285, October 2002.
Andrew R. Rose is an NBER Research Associate in the Program on
International Trade and Investment and the B.T. Rocca Professor of
International Business at University of California, Berkeley.