World Trade: An Overview: Slides Prepared by Thomas Bishop

Chapter 2
World Trade:
An Overview
Slides prepared by Thomas Bishop
Copyright 2009 Pearson Addison-Wesley. All rights reserved.
Preview
The largest trading partners of the U.S.
Gravity model:
influence of an economys size on trade
distance and other factors that influence trade
Borders and trade agreements

Globalization: then and now
Changing composition of trade
Service outsourcing
Copyright2009PearsonAddisonWesley.
22
Who Trades with Whom?

The 5 largest trading partners with the
U.S. in 2005 were Canada, China,
Mexico Japan and Germany.
The total value imports from and exports
to Canada in 2005 was about $500 billion
dollars.
The largest 10 trading partners with the
U.S. accounted for 56% of the value of
U.S. trade in 2005.
23
Fig. 2-1: Total U.S. Trade with Major

Partners, 2006
Source:U.S.DepartmentofCommerce
24
Size Matters: The Gravity Model

3 of the top 10 trading partners with the U.S.
in 2005 were also the 3 largest European economies:
Germany, UK, and France.
These countries have the largest gross domestic
product (GDP) in Europe.
GDP measures the value of goods and services
produced in an economy.
Why does the U.S. trade most with these European

countries and not other European countries?
25
Size Matters: The Gravity Model (cont.)

In fact, the size of an economy is directly
related to the volume of imports and exports.
Larger economies produce more goods and
services, so they have more to sell in the
export market.
Larger economies generate more income from
the goods and services sold, so people are able
to buy more imports.
26
Fig. 2-2: The Size of European Economies, and

the Value of Their Trade with the United States
Source:U.S.DepartmentofCommerce,EuropeanCommission
27
The Gravity Model

Other things besides size matter for trade:
1. Distance between markets influences transportation
costs and therefore the cost of imports and exports.
Distance may also influence personal contact and

communication, which may influence trade.
2. Cultural affinity: if two countries have cultural ties, it

is likely that they also have strong economic ties.
3. Geography: ocean harbors and a lack of mountain
barriers make transportation and trade easier.
28
The Gravity Model (cont.)

4. Multinational corporations: corporations spread
across different nations import and export many
goods between their divisions.
5. Borders: crossing borders involves formalities that
take time and perhaps monetary costs like tariffs.
These implicit and explicit costs reduce trade.
The existence of borders may also indicate the existence of

different languages (see 2) or different currencies, either of
which may impede trade more.
29

In its basic form, the gravity model assumes that only
size and distance are important for trade in the
following way:
Tij = A x Yi x Yj /Dij
where
Tij is the value of trade between country i and country j
A is a constant
Yi the GDP of country i
Yj is the GDP of country j
Dij is the distance between country i and country j
210

In a slightly more general form, the gravity model that
is commonly estimated is
Tij = A x Yia x Yjb /Dijc
where a, b, and c are allowed to differ from 1.
Perhaps surprisingly, the gravity model works fairly

well in predicting actual trade flows, as the figure
above representing U.S.EU trade flows suggested.
211
Distance and Borders

Estimates of the effect of distance from the
gravity model predict that a 1% increase in
the distance between countries is associated
with a decrease in the volume of trade of
0.7% to 1%.
212
Distance and Borders (cont.)

Besides distance, borders increase the cost and time
needed to trade.
Trade agreements between countries are intended to
reduce the formalities and tariffs needed to cross
borders, and therefore to increase trade.
The gravity model can assess the effect of trade
agreements on trade: does a trade agreement lead to
significantly more trade among its partners than one
would otherwise predict given their GDPs and
distances from one another?
213

The U.S. signed a free trade agreement with
Mexico and Canada in 1994, the North
American Free Trade Agreement (NAFTA).
Because of NAFTA and because Mexico
and Canada are close to the U.S., the
amount of trade between the U.S. and its
northern and southern neighbors as a fraction
of GDP is larger than between the U.S. and
European countries.
214
Fig. 2-3: Economic Size and Trade

with the United States
Source:U.S.DeparmentofCommerce,EuropeanCommission
215

Yet even with a free trade agreement between
the U.S. and Canada, which use a common
language, the border between these countries
still seems to be associated with a reduction
in trade.
216
Fig. 2-4: Canadian Provinces and U.S.

States That Trade with British Columbia
217
Table 2-3: Trade with British Columbia, as

Percent of GDP, 1996
218
Has the World Become Smaller?

The negative effect of distance on trade according
to the gravity models is significant, but it has grown
smaller over time due to modern transportation
and communication.
Wheels, sails, compasses, railroads, telegraph, steam
power, automobiles, telephones, airplanes, computers, fax
machines, internet, fiber optics, personal digital assistants,
GPS satellites are technologies that have increased trade.
But history has shown that political factors, such as

wars, can change trade patterns much more than
innovations in transportation and communication.
219
Has the World Become Smaller? (cont.)

There were two waves of globalization.
18401914: economies relied on steam power,
railroads, telegraph, telephones. Globalization was
interrupted and reversed by wars and depression.
1945present: economies rely on telephones,
airplanes, computers, internet, fiber optics, PDAs,
GPS satellites
220
Has the World Become Smaller? (cont.)

Only in the last few decades has international
trade become more important to the British
economy than it was in 1910.
Even today, international trade is less
important for the U.S. than it was to the UK
before 1910.
221
Fig. 2-5: The Rise, Fall, and Rise of

International Trade Since 1830
Source:RichardE.BaldwinandPhillipeMartin,TwoWavesofGlobalization:SuperficialSimilarities,Fundamental
Differences,inHorstSiebert,ed.,GlobalizationandLabor(Tubingen:Mohr,1999).
222
Changing Composition of Trade

What kinds of products do nations currently trade,
and how does this composition compare to trade in
the past?
Today, most of the volume of trade is in manufactured
products such as automobiles, computers, clothing
and machinery.
Services such as shipping, insurance, legal fees, and
spending by tourists account for 20% of the volume of trade.
Mineral products (ex., petroleum, coal, copper) and
agricultural products are a relatively small part of trade.
223
Fig. 2-6: The Composition of World

Trade, 2005
Source:WorldTradeOrganization
224
Changing Composition of Trade (cont.)

In the past, a large fraction of the volume of trade
came from agricultural and mineral products.
In 1910, Britain mainly imported agricultural and mineral
products, although manufactured products still represented
most of the volume of exports.
In 1910, the U.S. mainly imported and exported agricultural
products and mineral products.
In 2002, manufactured products made up most of the volume
of imports and exports for both countries.
225
Table 2-4: Manufactured Goods as a

Percent of Merchandise Trade
226
Changing Composition of Trade (cont.)

Low and middle-income countries have also
changed the composition of their trade.
In 2001, about 65% of exports from low and
middle-income countries were manufactured
products, and only 10% of exports were
agricultural products.
In 1960, about 58% of exports from low and
middle-income countries were agricultural products
and only 12% of exports were manufactured
products.
227
Fig. 2-7: The Changing Composition of

Developing-Country Exports
Source:UnitedNationsCouncilonTradeandDevelopment
228
Service Outsourcing (cont.)

Service outsourcing occurs when a
firm that provides services moves its
operations to a foreign location.
Service outsourcing can occur for services
that can be performed and transmitted
electronically.
For example, a firm may move its customer
service centers whose telephone calls can be
transmitted electronically to foreign location.
229
Service Outsourcing (cont.)

Service outsourcing is currently not a
significant part of trade, but about 19% of
service jobs are tradeable and thus have the
potential to be outsourced.
In comparison, about 12% of manufacturing jobs
are tradeable and thus have the potential to be
outsourced.
Most jobs, however, are non-tradeable because
they need to be done close to the customer.
230
Fig. 2-8: Tradable Industries Share of

Employment
Source:J.BradfordJensenandLoriG.Kletzer,TradableServices:UnderstandingtheScopeandImpactof
ServicesOutsourcing,PetersonInstituteofEconomicsWorkingPaper509,May2005
231
Summary
1. The 5 largest trading partners with the U.S. are
Canada, China, Mexico, Japan, and Germany.
2. The largest economies in the EU undertake
the largest fraction of the total trade between
the EU and the U.S.
3. The gravity model predicts that the volume of
trade is directly related to the GDP of each
trading partner and is inversely related to the
distance between them.
232
Summary (cont.)
4.
Besides size and distance; culture, geography,

multinational corporations, and the existence of
borders influence trade.
5.
Modern transportation and communication have

increased trade, but political factors have influenced
trade more in history.
6.
Today, most trade is in manufactured goods, while

historically agricultural and mineral products made
up most of trade.
233
AdditionalChapterArt
234
Table 2-1 Hypothetical World Spending

Shares and GDP
235
Table 2-2 Values of Exports ($ trillion)
236

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Chapter 2

Slides prepared by Thomas Bishop

Copyright 2009 Pearson Addison-Wesley. All rights reserved.

Borders and trade agreements

Who Trades with Whom?

Fig. 2-1: Total U.S. Trade with Major

Size Matters: The Gravity Model

Why does the U.S. trade most with these European

Size Matters: The Gravity Model (cont.)

Fig. 2-2: The Size of European Economies, and

The Gravity Model

Distance may also influence personal contact and

2. Cultural affinity: if two countries have cultural ties, it

The Gravity Model (cont.)

These implicit and explicit costs reduce trade.

The existence of borders may also indicate the existence of

The Gravity Model (cont.)

The Gravity Model (cont.)

Perhaps surprisingly, the gravity model works fairly

Distance and Borders

Distance and Borders (cont.)

Distance and Borders (cont.)

Fig. 2-3: Economic Size and Trade

Distance and Borders (cont.)

Fig. 2-4: Canadian Provinces and U.S.

Table 2-3: Trade with British Columbia, as

Has the World Become Smaller?

But history has shown that political factors, such as

Has the World Become Smaller? (cont.)

Has the World Become Smaller? (cont.)

Fig. 2-5: The Rise, Fall, and Rise of

Changing Composition of Trade

Fig. 2-6: The Composition of World

Changing Composition of Trade (cont.)

Table 2-4: Manufactured Goods as a

Changing Composition of Trade (cont.)

Fig. 2-7: The Changing Composition of

Service Outsourcing (cont.)

Service Outsourcing (cont.)

Fig. 2-8: Tradable Industries Share of

Besides size and distance; culture, geography,

Modern transportation and communication have

Today, most trade is in manufactured goods, while

Table 2-1 Hypothetical World Spending

Table 2-2 Values of Exports ($ trillion)

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