ECO ESSAY
YANGYANG
2.Gravity.pptx2 World Trade: Overview
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Preview
Largest trading partners of the United States
Gravity model:
Influence of an economy’s size on trade
Distance and other factors that influence trade
Borders and trade agreements
Globalization: then and now
Changing composition of trade
Service outsourcing
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1. Who Trades with Whom?
More than 30% of world output is sold across national borders.
World trade in goods and services exceeded $21 trillion in 2015.
The 5 largest trading partners with the U.S. in 2015 were China, Canada, Mexico, Japan, and Germany.
The largest 15 trading partners with the U.S. accounted for 75% of the value of U.S. trade in 2015.
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Total U.S. Trade with Major Partners, 2015, Millions
Source: U.S. Department of Commerce
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2. The Gravity Model
3 of the top 10 trading partners with the U.S. in 2016 were also the 3 largest European economies: Germany, U.K., 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?
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2. The Gravity Model
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 they are able to buy more imports.
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The Size of European Economies, and the Value of Their Trade with the United States
Source: U.S. Department of Commerce, European Commission
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2. The Gravity Model
A gravity model fits the data on U.S. trade with European countries well but not perfectly.
The Netherlands, Belgium and Ireland trade much more with the United States than predicted by a gravity model.
Ireland has strong cultural affinity due to common language and history of migration.
The Netherlands and Belgium have transport cost advantages due to their location.
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2. The Gravity Model
Other things besides size matter for trade:
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.
Cultural affinity: If two countries have cultural ties, it is likely that they also have strong economic ties.
Geography: Ocean harbors and a lack of mountain barriers make transportation and trade easier.
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2. The Gravity Model
Multinational corporations: Corporations spread across different nations import and export many goods between their divisions.
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.
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2. The Gravity Model
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
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2. The Gravity Model
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.
Despite its simplicity, the gravity model works fairly well in predicting actual trade flows, as the figure above representing U.S.–EU trade flows suggested.
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2. The Gravity Model
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%.
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3. Borders and Trade Agreements
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?
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3. Borders and Trade Agreements
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.
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Economic Size and Trade with the United States
Source: U.S. Department of Commerce, European Commission.
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3. Borders and Trade Agreements
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.
Data shows that there is much more trade between pairs of Canadian provinces than between Canadian provinces and U.S. states, even when holding distance constant.
Estimates indicate that the U.S.-Canadian border deters trade as much as if the countries were 1,500-2,500 miles apart.
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Canadian Provinces and U.S. States That Trade with British Columbia
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Trade with British Columbia, as Percent of GDP, 1996
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4. Globalization: Has the World Become “Smaller”?
The negative effect of distance on trade according to the gravity models is significant, but has grown smaller over time due to modern transportation and communication.
Technologies that have increased trade:
Wheels, sails, compasses, railroads, telegraph, steam power, automobiles, telephones, airplanes, computers, fax machines, Internet, fiber optics, personal digital assistants, GPS satellites…
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4. Globalization: Has the World Become “Smaller”?
Political factors, such as wars, can change trade patterns much more than innovations in transportation and communication.
World trade grew rapidly from 1870 to 1913.
Then it suffered a sharp decline due to the two world wars and the Great Depression.
It started to recover around 1945 but did not recover fully until around 1970.
Since 1970, world trade as a fraction of world GDP has achieved unprecedented heights.
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Table 2-2: World Exports as a Percentage of World GDP
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5. Changing Composition of Trade
What kinds of products do nations trade now, and how does this composition compare to the past?
Most (about 57%) of the volume of trade today is in manufactured products such as automobiles, computers, and clothing.
Services such as shipping, insurance, legal fees, and spending by tourists account for about 24% of the volume of trade.
Mineral products (ex., petroleum, coal, copper) remain an important part of world trade at 12%
Agricultural products are a relatively small part of trade at 8%.
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The Composition of World Trade, 2015
Source: World Trade Organization
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5. Changing Composition of Trade
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 2015, manufactured products made up most of the volume of imports and exports for both countries.
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Table 2-3: Manufactured Goods as a Percent of Merchandise Trade
| blank | Exports of United Kingdom | Imports of United Kingdom | Exports of United States | Imports of United States |
| 1910 | 75.4 | 24.5 | 47.5 | 60.7 |
| 2015 | 72.3 | 73.6 | 74.8 | 78.4 |
Source: 1910 data from Simon Kuznets, Modern Economic Growth: Rate, Structure and Speed. New Haven: Yale Univ. Press, 1966. 2015 data from World Trade Organization.
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5. Changing Composition of Trade
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.
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Fig. 2-6: The Changing Composition of Developing-Country Exports
Source: United Nations Council on Trade and Development
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6. Service Outsourcing
Service outsourcing (or offshoring) 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 a foreign location.
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6. Service Outsourcing
Service outsourcing is currently not a significant part of trade.
Some jobs are “tradable” and thus have the potential to be outsourced.
Most jobs are nontradable because they need to be done close to the customer.
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Tradable Industries’ Share of Employment
Source: J. Bradford Jensen and Lori G. Kletzer, “Tradable Services: Understanding the Scope and Impact of Services Outsourcing,” Peterson Institute of Economics Working Paper 5-09, May 2005
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Summary
The 5 largest trading partners with the U.S. are Canada, China, Mexico, Japan, and Germany.
The largest economies in the EU undertake the largest fraction of the total trade between the EU and the U.S.
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.
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Summary
Besides size and distance, culture, geography, multinational corporations, and the existence of borders influence trade.
Modern transportation and communication have increased trade, but political factors have influenced trade more in history.
Today, most trade is in manufactured goods, while historically agricultural and mineral products made up most of trade.
