“postponable purchases”The dimensions of the trade shock in 2008

A prominent feature of global economic performance during and since the financial crisis of 2008 has been first a sharp and rapid contraction in global trade, and secondly it's equally sharp recovery from mid-2009 onwards.

Explaining this phenomenon is something which now preoccupies international trade economists. The size of the compression exceeds anything recorded during the 1997-1998 Asian Financial Crisis, or in the 1929-1933 Great Depression when trade implosion exceeded GDP fall in the first year reduction in proportional terms was less than that experienced in 2008.

In the 1930s reductions in North America and Europe continued month after month until early 1933, and cumulatively exceeded those in 2008, but the immediate 2008 impact was larger.

The dimensions of the trade shock in 2008 are worth noting. By first quarter of 2009 year on year monthly trade growth figures for the world economy were running at around negative 25 per cent.

In Asia, where economies such as China and Japan were large manufactures exporters trade impacts were larger negative. In the Chinese case, pre crisis trade growth had been running at around 30 per cent/year, and a reversal to around -20 per cent annual growth is effectively close to a 50 per cent reduction in trade.

Ever since the 1940s and through the postwar years the global economy had become ever more integrated across national borders. In the 1950s through to the 1980s trade growth globally had run on average at rates which were roughly double those of GDP growth in major economies.

In the 1980s through to 2007 this process further accelerated with trade growth approximately triple GDP growth. In the case of the US in the mid-1950s imports were running at around 4 to 5 per cent of GDP. By the late 1990s, imports by the US accounted for nearly 30 per cent of GDP. Similar degrees of changing integration had been observed in Europe and Asia.

It was the growing importance and relative size of trade which had preoccupied economists in the pre-crisis world. Various explanations were offered. One claim was that the fastest-growing portion of world trade was in manufactures between richer countries, and this was often in similar products.

This intra-industry trade was thought of as, in effect, trading in variety of products (Italian designer shoes, French perfume). And variety in consumption of products was thought to be a luxury good, so that as global incomes rose with growth and integration so trade grew at rates in excess of GDP growth.

Another claim was significant declines globally in transportation costs along with the change over time in product composition towards high-value and low weight/volume items (ie - trade in computer chips rather than trade in coal). Finally came the argument that trade liberalisation globally both under GATT/WTO and through unilateral trade liberalization had greatly lowered trade barriers relative to the 1940s, and this had served to fuel trade growth in excess of income growth.

While these factors may reasonably, in combination, account for proportionally higher growth of trade on the upside for an expanding growing world economy which in the three years before the crisis grew at nearly 5 per cent, they are implausible explanations for a much sharper effect operating in reverse with the onset of the 2008 crisis, and also occurring with the speed at which reductions were experienced.

Variety effects, and the withdrawal of demand for variety in the face of an income compression in 2009 of perhaps 4 per cent globally simply does not seem to be able to account for a 25 per cent reduction in trade. And trade barriers hardly changed in a year, and neither had transportation costs.

So what could account for the trade collapse, and it occurring so quickly? One key factor was the role of expectations. It wasn't just that an income reduction of roughly 4 per cent globally occurred in the first year; it was that at onset in September/October 2008 the rapid financial implosion conjured up vistas of far worse to come.

At impact, then, the first point of departure from previous experience was that the expected downside impact seemed substantially larger than the actual impact that was to occur over some months. And if the expectation of impact drove performance, so the impact on global trade was correspondingly much larger.

But it would seem that it was more than an expectational effect. With financial collapse and seeming financial system failure, liquidity available to firms and consumers became an all important determinant of economic behavior. And faced with potential liquidity difficulties, the reaction of both firms and consumers was to postpone purchases as much as possible.

The immediate impact of the crisis on consumer behavior was a sharp reduction in postponable purchases of durable goods, such as autos. And at the firm level, the impact fell heavily on inventory accumulation. Purchases were postponed, stocks were run down, and hence liquidity preserved until things clarified. The impact was reduction in all trade including within as well as between nation states. Because trade is only recorded through customs records, we only observe international trade not internal trade within economies, but inventory deccumulation hit all forms of trade, and hit hard and quickly.

This in turn points to the factors behind the sharp and quick rebound in trade. As the turmoil from the 2008 crisis slowly subsided and the situation stabilised so restocking and replacement inventory accumulation occurred. 2008 differs from 1929-1933 both in severity and also in duration and policy response. The trade impacts of the crisis may continue be to be studied, but pre crisis trade behavior gives little indication of the impacts driving and ultimately following the crisis.

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