Wednesday, July 8, 2009

Elasticity of global trade

In a Vox article, Caroline Freund of the World Bank traces the dramatic decline in global trade during the ongoing recessions to the increased elasticity of real world trade to real world income from around 2 in the 1960s and 1970s to above 3.5 now. She attributes this to the fragmentation of the production process across countries.

She argues that since GDP is a value-added measure while trade is a gross measure, an increase in GDP may lead to more outsourcing and much more measured trade, as an increasing number of parts travel around the globe to be assembled and delivered to their final consumer. Her studies find the greatest responsiveness of regional exports to global income in East Asia – a 1% increase in real world income leads to 4.5% increase in real exports since 1995.

Assuming an elasticity of trade to income during the downturn of between 3.5 and 5, and a deceleration in real world income growth of 4.7 percentage points (the current World Bank estimate), she estimates the deceleration in real trade growth to be between 16-24 percentage points in 2009.

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