Don't blame trade restrictions this time. Instead, the three culprits are the credit crunch, the "compositional effect" and the trend away from making an entire product in one country.International trade

Hoda S. El-Ghazaly

Silvio Contessi

English

Research Papers in Economics

long with the spread of the financial  
crisis that began in 2007, the world  
experienced the largest recession since the 
Great Depression.  According to the Inter-
national Monetary Fund, world GDP fell by  
0.8 percent in 2009, while advanced econo-
mies experienced a contraction of 3.2 per- 
cent, the largest decline in the past 50 years.  
Exports from the advanced economies fell 
even more, by a staggering 12.3 percent, about 
four times as much as the drop in GDP and 
approximately as much as exports to the 
advanced economies.
The figure shows the rate of growth of U.S. 
GDP, imports and exports, as well as a pattern 
that was common to many other countries 
during the crisis:  The imports and exports of 
advanced, emerging and developing econo-
mies fell by similar percentages, ranging from 
a minimum of 11.7 percent to a maximum of 
13.5 percent.  Similarly, the rebound of U.S. 
trade flows that appears in the figure at the 
end of 2009 was observed in other countries.
The larger-than-expected drop in trade 
has puzzled economists and commentators 
throughout the current recession.  A number 
of trade scholars are looking into potential 
culprits.
The suspect that can be easily discarded is 
trade restrictions.  Unlike during other reces-
sions and the Great Depression, countries 
have not used trade measures—such as tariffs, 
quotas or anti-dumping measures—during 
this recession to restrict imports.  One reason 
is the World Trade Organization forbids these 
measures; another reason is we now under-
stand that trade restrictions worsened the 
Great Depression.
The remaining causes for the plummet in 
exports are more difficult to discard:  the col-
lapse of trade finance, the increase in vertical 
specialization and the composition of trade 
flows.  Traditional textbook analysis of trade 
dynamics during recessions attributes  
trade decline to lower demand for final good  
imports in the country experiencing a con-
traction.  However, the changes in the way 
trade is financed and organized, along with 
a better understanding of the international 
economy, induced economists to focus on the 
three elements we discuss here.
First Suspect: Finance
Various studies have documented the 
importance of finance for international trade 
transactions, as financial institutions are key 
suppliers of services such as the evaluation of 
counterparty default risk and the provision  
of payment insurance and guarantees to  
exporters.  Economist Marc Auboin esti-
mated that about 90 percent of international 
trade transactions rely on one form or 
another of trade finance. 
Therefore, the conjecture is that the credit 
crunch may have caused the large decline 
in world trade by reducing firms’ access to 
finance.  A study by economists Mary Amiti 
and David Weinstein has shown that a similar 
mechanism was at work during the Japanese 
crisis of the late 1990s and early 2000s.  They 
found that lack of financing accounted for 
nearly one-third of the plunge in Japanese 
exports during the 1990s. 
Fresh evidence for the current recession is 
hard to come by and to date exists only for 
exports to the U.S.  Economists Davin Chor 
and Kalina Manova found that countries with 
tighter credit availability during the crisis 
exported less to the U.S.  Moreover, exports to 
the U.S. contracted more in sectors that other 
research has shown to be more heavily depen-
dent on extensive external financing.  This 
early evidence suggests that the trade finance 
nexus seems to be one of the explanations 
of the trade contraction during the current 
crisis, at least for the U.S. 
Second Suspect: Vertical Fragmentation
The second suspect is vertical fragmenta-
tion, a form of international trade that has 
been growing exponentially with the spread 
of globalization in the past 20 years.  We 
normally think of international trade as being 
dominated by final goods, those that do not 
need further processing.  On the contrary, 
the data show that international trade in 
industrialized countries is dominated by 
capital goods (such as machinery) and other 
types of intermediate goods (such as steel) 
that are normally used for the production of 
consumer goods.  In the case of the U.S., these 
intermediate goods account for nearly three-
fourths of total imports and exports.  
As massive freighters have minimized the 
cost of transport, international sharing of pro-
duction has increased.  Goods are increasingly 
manufactured in stages in different countries.  
Before a product is completed and shipped to 
its final destination, its components have often 
crossed borders several times.
Consider the example of the iPhone.  Its 
CPU and video processing are made in Sin-
gapore.  Its digital camera, circuit boards and 
metal casings are made in Taiwan.  Its touch-
screen controllers are made in the U.S.  From 
these countries, all components are then 
shipped and assembled in Shenzhen, China, 
before being delivered to final consumers in 
various countries.  Complete iPhones arrive 
to American consumers after the phones’ 
components have crossed at least four bor-
ders, including the U.S. border twice. 
If the demand for final goods declines, the 
first effect is that the demand for intermedi-
ate goods suffers in each of the countries 
in which production takes place.  At the 
g l o b a l   e c o n o m y
The Trade Collapse:  
Lining Up the Suspects
By Silvio Contessi and Hoda El-Ghazaly
© Kevin Fleming/CORBiS
10   The Regional Economist  |  April 2010same time, international trade also appears 
to suffer more than GDP because at each 
border crossing the full value of the partly 
assembled good is recorded as trade, while 
GDP measures only value added.  In order to 
understand the difference, consider a simple 
good like a pencil, made of two components, 
wood and graphite, assembled using labor.  
When the pencil is produced entirely in the 
U.S., its contribution to U.S. GDP is the final 
price to consumers (say $1) net of the cost 
of its components (80 cents); therefore, 20 
cents of value has been added.  When the 
pencil is only assembled in the U.S. but its 
components are imported from Canada, 
for example, and demand for pencils in the 
U.S. falls by one unit, U.S. GDP falls by 20 
cents, but U.S. imports from Canada fall by 
80 cents, four times as much!  This happens 
because GDP is a value-added measure while 
trade is a gross measure.
Economist Caroline Freund estimates that 
when world income increases by 1 percent 
these days, trade increases, on average, by 3.5 
percent.  In the 1960s, the impact of an equiva-
lent change in income on trade was only 2 
percent.  This is likely related to the increase  
in vertical specialization.  Various other 
economists have provided evidence that the 
recent decline in trade is stronger in sectors 
that make intense use of intermediate inputs. 
Third Suspect: Compositional Effect
During recessions, consumers and firms 
demand fewer goods; however, the decline in 
demand is less than equal across all indus-
tries because some sectors are more impacted 
than others.  When households and firms 
adjust their spending downward, the demand 
for both domestic and imported goods falls.  
Now, if international trade is concentrated 
in the sectors that are most impacted by the 
negative economic shock, then overall trade 
should experience a greater fall than GDP.  
For example, consider the case in which over-
all U.S. GDP declines by 2 percent, but the 
agricultural component of GDP falls by, say,  
7 percent.  If trade is particularly concentrated 
in agriculture, then we would observe a drop 
in trade larger than the drop in overall GDP.
The composition of the decline in demand 
may affect the magnitude of the decline in 
trade simply because there may be more trade   
in the sectors that were hit the hardest.  Econ- 
omists Andrei Levchenko, Logan Lewis and 
Linda Tesar show that this is exactly what 
happened to the U.S. during the current 
recession; the largest declines in trade are 
recorded for those sectors that had the larg-
est drops in output (industrial supplies and 
materials, computers, peripherals and parts, 
automotive vehicles, engines and parts).  This 
may also explain why international trade in 
services other than finance, transport and 
tourism fell by much less than overall trade, 
as the service component of GDP fell much 
less than overall GDP during the crisis. 
A One-Time Thing?
The international economy operates as a 
network in which the line between producer 
and consumer continues to zig-zag and blur.  
In such a world, it is key to recognize those 
factors that have the most influence on inter-
national trade.  Economists have identified 
three main suspects as the leading causes of 
declining trade volumes during the current 
recession and, by lining up the suspects, they 
have been able to analyze the causes’ indivi-
dual contributions to the trade collapse, at 
least for the U.S.  As new data from the cur-
rent crisis become available, other countries 
will be studied in order to help us understand 
whether the large drop in trade is specific  
to this recession or will likely reappear in  
future recessions.  In the meantime, most  
projections for this year indicate a recovery  
in world GDP (3.9 percent in the World  
Economic Outlook of the International  
Monetary Fund) and in world trade (a robust 
5.8 percent increase).  
Silvio Contessi is an economist and Hoda  
El-Ghazaly is a research associate at the 
Federal Reserve Bank of St. Louis.  For more on 
Contessi’s work, see http://research.stlouisfed.
org/econ/contessi
R e f e R e nC e S
Auboin, Marc.  “Boosting Trade Finance in 
Developing Countries: What Link with the 
WTO?”  Working Paper ERSD-2007-04, 
World Trade Organization, November 2007.
Amiti, Mary; and Weinstein, David.  “Exports 
and Financial Shocks.”  Working Paper 15556, 
National Bureau of Economic Research, 
December 2009.
Borchert, Ingo; and Mattoo, Aaditya.  “The 
Crisis-Resilience of Services Trade.”  Working 
Paper 4917, the World Bank, April 2009.
Chor, Davin; and Manova, Kalina.  “Off the Cliff 
and Back: Credit Conditions and Interna-
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Crisis.”  Stanford University Manuscript, 
December 2009.
Coughlin, Cletus.  “World Trade: Pirated by  
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Economist, The.  “The Collapse of Manufactur-
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Freund, Caroline.  “Demystifying the Collapse 
in Trade.”  VoxEU.org, July 3, 2009.   
See www.voxeu.org/index.php?q=node/3731
Levchenko, Andrei; Lewis, Logan; and Tesar, 
Linda.  “The Collapse of U.S. Trade: In Search 
of the Smoking Gun.”  VoxEU.org, Novem-
ber 27, 2009.  See www.voxeu.org/index.
php?q=node/4280
World Trade Organization.  “WTO Sees 9% 
Global Trade Decline in 2009 as Recession 
Strikes.”  (Press release from March 24, 2009.)  
See www.wto.org/english/news_e/pres09_ 
e/pr554_e.htm
Yi, Kei-Mu.  “The Collapse of Global Trade: The 
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lapse of Global Trade, Murky Protectionism, 
and the Crisis: Recommendations for the 
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March 2009.  See www.voxeu.org/reports/
Murky_Protectionism.pdf
The Regional Economist  |  www.stlouisfed.org   11
       
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5
0
–5
–10
–15
–20
U.S. Exports
U.S. Imports
U.S. GDP
PERCENT CHANGE YEAR-TO-YEAR
SOURCe: Authors’ calculations based on data from the U.S. Census Bureau and the Bureau of economic Analysis.
Growth Rates

The trade collapse: lining up the suspects

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The trade collapse: lining up the suspects

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