Thursday, September 17, 2009

Does this Recession Make the World Look Fat?

In 2005 Thomas Friedman declared the world flat, but I always liked Ed Leamer's review in JEL, which points out the fact that it's a strange, and perhaps inapt analogy (he also makes pokes fun with some very esoteric "jokes" about different notions of what "flat" might mean, but that's besides the point). A new historical view by David Jacks (HT: Economix) shows us how the late 20th century decline in trade costs (and increases in trade) pales in comparison to those of the late 19th century (something I've observed in my undergrad classes already by the way!). Anyway, trade is down by greater proportions than those observed during the Great Depression and everyone has their culprit of choice. Some talk about oil prices (although I'm not sure that in real terms oil and fuel is all that much more expensive now than it was in the late 1990s); some blame a general downturn (although I'm pretty sure the downturn in the G.D. was much greater, without even checking the data); and others put it on governments and protectionism (although this too has been tame compared with the Depression Era).
The answer to me is twofold: (1) 1990s globalization centered on growth in components; and (2) trade is not a value-added concept like output is. For the first, the basic idea is that instead of countries specializing and producing all of certain finished goods that are consumed by end users, the recent explosion in trade was in components - countries specialized in a particular part of the finished good. Since trade is not a value-added concept, so within this integrated supply chain, you can have the value-added of a 20,000 dollar auto counted many times - the steel ($5,000) gets shipped from China to 3 other countries where components are made (at, say, $2,000 of value added in GDP per country), then to Mexico for assembly (another $4,000), then managerial, transportation marketing services by the US (for about another $3,000), and sold in Canada for $20,000 (the retailer's value-added is $1,000). If this car disappears from world trade, it amounts to a reduction of world GDP of exactly $20,000 because GDP only counts value-added. However, trade (imports plus exports is a common measure) is reduced by $(5,000 + 11,000 + 15,000 + 19,000)x2 = $80,000 due to the multiple counting of the total value at each stage of shipping instead of only counting each country's value-added.
So, the world is not getting fat (it's approximately as flat as it was last year) and I'm neither shocked nor alarmed at the decline in trade (at least, no more shocked or alarmed than I am about the decline in output generally).

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