Durable Goods and the Collapse of Global Trade by Jian Wang

Vol. 5, No. 2 FEBRUARY 2010­­ EconomicLetter

Insights from the F e d e r a l R eserve Bank o f D a l l a s

Durable Goods and the Collapse of Global Trade by Jian Wang

Due to the financial Global trade has experienced a stunning collapse in the current re-

crisis, worldwide cession, with the World Trade Organization estimating a decrease of roughly

demand for durable 9 percent in 2009—the biggest contraction since the Second World War.1 Both

goods dropped imports and exports plunged in major trading countries (Chart 1).

substantially. The The swift decline caused substantial damage to the global economy,

decline inevitably hitting Japan and other countries with large trade sectors especially hard. It

caused a plunge in also raised concerns that the trade collapse would worsen the global recession

global trade. and delay recovery.

Several factors contributed to the global trade collapse. However,

the ultimate causes are tied to the global financial crisis that started in

mid-2007. Financial markets deteriorated over the next year, and the global

economy’s growth prospects shifted suddenly in September 2008. In the final months of the year, the forecast for Chart 1 2009 gross domestic product (GDP) growth went from a moderate slow- Import and Export Growth Rates Fall down to a sharp contraction (Chart 2). as Recession Deepens Consumers and investors world- wide started to realize that the financial crisis’ impact on real economies may A. Real Imports B. Real Exports be longer and more severe than they Percent* Percent* had expected. They pulled back signif- 0 0 icantly, leading to declines in total con- sumption and investment that spilled

–10 –10 over into global trade. Particularly hard hit were consumer and producer –20 purchases of long-lasting goods. We –20 will see that demand for these durable –30 goods played an important role in the –30 recent global trade collapse. –40 –40 Trade Volatility and GDP –50 The last quarter of 2008 saw GDP –50 2008:Q4 2008:Q4 plunge in much of the world, includ- –60 2009:Q1 2009:Q1 ing key countries such as the U.S., Germany, Japan and the U.K. (Chart –60 –70 U.S. Germany Japan U.K. U.S. Germany Japan U.K. 3). Understanding how such declines

*Quarter/quarter, annualized. in economic activity impact interna-

SOURCE: Organization for Economic Cooperation and Development. tional trade starts with a look at two persistent patterns in the trade data. First, imports and exports are much more volatile than GDP. Second, they generally move in the same direction as GDP. The upshot is that Chart 2 a steep drop in a country’s GDP usu- 2009 GDP Growth Forecasts Turn Gloomy During 2008 ally results in an even steeper drop in imports and exports. Using the U.S. as an example, we

Annual GDP growth (percent) look at annualized quarter-to-quarter 3 changes in imports, exports and GDP Sept. 2008 since 1980. Over this period, both 2 imports and exports show much big- ger variations than GDP (Chart 4). The 1 wide fluctuations obscure the fact that imports and exports are also positively 0 correlated with GDP—particularly in the early 1990s, the first few years of –1 Euro area Japan the 2000s and the most recent period U.S. 2 –2 of economic turmoil. U.K. Trade volatility and a posi- –3 tive comovement with GDP aren’t Jan. Feb. Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. 2008 2009 limited to U.S. data. Measured by Date of forecast their standard deviations, imports SOURCE: Consensus Economics’ Consensus Forecasts. and exports are about three times as volatile as GDP in most Organization for Economic Cooperation and Development (OECD) countries.3

EconomicLetter 2 Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas EconomicLetter Imports and exports are also positively correlated with GDP in nearly all of Chart 3 these countries.4 Like the U.S., most industrial coun- Real GDP Declines in Some Major Economies in 2008–09 tries experienced sharp declines in their GDPs in the recent global financial cri- Percent* sis. It’s not surprising that their imports 4

and exports fell even more sharply. 2 The fact that imports and exports have greater volatility than GDP ex- 0 plains why international trade plunges –2

in deep recessions. But why is trade –4 so much more volatile than GDP? The answer is that durable goods make up –6 a large fraction of international trade— –8

and demand for them is usually very –10 2008:Q3 volatile. 2008:Q4 –12 2009:Q1

–14 2009:Q2 Trade in Durable Goods 2009:Q3 Durable consumption goods and –16 Germany Japan U.K. private capital investment factor into U.S.

durables trade. Durable goods yield *Quarter/quarter, annualized.

service or utility over time. Examples SOURCES: National statistical offices; Organization for Economic Cooperation and Development. include such capital goods as machin- ery and such consumer goods as automobiles, appliances and big-screen TVs. When the economy is expected to turn sour, households can put off pur- Chart 4 chases of consumer durables but can’t U.S. Imports and Exports Vary More than GDP easily delay purchases of food and other goods for quick consumption. When inventories start to grow, firms Percent growth* don’t expand capacity, and they cancel 40

or postpone new investments. Thus, 30 demand is generally much more vola- tile for durable consumer goods and 20 investment than for nondurable goods. 10 Once again, the U.S. provides a good example. We look at annualized, 0 quarter-to-quarter percent changes in the output of both durable goods and –10

nondurable goods and services. The –20 Imports data show that durables are more vola- Exports

tile than nondurables (Chart 5). –30 GDP Durable goods represent a mod- –40 erate share of the economy in most 1980 1984 1988 1992 1996 2000 2004 2008 industrial countries—in the U.S., for example, they accounted for 23.6 per- *Quarter/quarter, annualized. cent of real GDP in 2008. However, SOURCE: Organization for Economic Cooperation and Development. durable goods make up a large share of international trade. In the U.S., they accounted for more than 60 percent of trade in goods (excluding energy

EconomicLetter Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas 3 EconomicLetter products) in 2008. The figure is 70 per- Chart 5 cent on average for the OECD coun- tries, according to several studies.5 Growth Rates More Volatile for Durable Due to the global financial cri- than Nondurable Goods in U.S. sis, worldwide demand for durable goods dropped substantially. In the first quarter of 2009, for instance, Percent* demand fell about 20 percent in the 30 U.S, Canada, Japan and the U.K., adding to the weakness of the pre- 20 vious two quarters (Chart 6). The Nondurable 10 decline inevitably caused a plunge in goods global trade.

0 Worse than Before? –10 We know that trade declines faster than GDP in hard times. But –20 Durable goods how do the declines this time compare with those in the previous downturn –30 in 2001? In absolute terms, the fall of U.S. –40 1985 1988 1991 1994 1997 2000 2003 2006 2009 imports and exports has been more severe than it was in the previous *Quarter/quarter, annualized. recession. However, GDP has also SOURCE: Bureau of Economic Analysis. declined much more this time. We need to take this into account in com- paring trade flows in the current and previous recessions. U.S. exports relative to GDP fell about 16 percent from the second Chart 6 quarter of 2008 to the second quarter Demand for Durable Goods Falls Off Globally of 2009—the same as they did from peak to trough in 2000–01. However,

Percent* the decline in imports has been much 5 deeper this time. As a share of GDP, they fell 18.3 percent—more than

0 twice as much as they did in the pre- vious downturn.

–5 The decline of durable goods contributed heavily to the fall of U.S. exports and imports in both reces- –10 sions, led by big drops in capital goods sales (see red section of bars, –15 Chart 7A). In the current recession, export –20 2008:Q3 2008:Q4 losses have been large in automotive 2009:Q1 vehicles, engines and parts (green); –25 U.S. Canada Japan U.K. the category held up much better in the less-severe downturn in 2001. *Quarter/quarter, annualized. Automobiles and consumer goods NOTE: Canada is used due to insufficient data from Germany. account for a large fraction of the SOURCE: Bureau of Economic Analysis. decline of U.S. imports this time, while capital goods less autos led the fall of imports in 2001 (Chart 7B).

EconomicLetter 4 Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas EconomicLetter These findings are consistent with the observation that U.S. households Chart 7 have substantially cut back durable goods consumption the past two Factors in the Fall of U.S. Real Exports and Imports years—in contrast to the previous recession, when durables purchases A. Capital Goods, Autos Drag Down Exports… increased (Chart 7C). This difference Percentage points* helps explain why U.S. imports have 30

declined much more in the current 20 recession than they did in 2001. 10

Other Mechanisms 0 The complexities of modern inter- –10 Capital goods, except automotives national trade factor into the demand –20 Automotive vehicles, engines and parts Consumer goods, except automotives for goods. Globally intertwined Industrial supplies and materials –30 Foods, feeds and beverages mechanisms such as financial markets, Other trade credit and vertical specializa- –40 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 tion likely exacerbated the plunge in worldwide demand for durable goods B. …and Do the Same to Imports… and the associated collapse of global trade. Percentage points* The rapid deterioration of the 20

global economy after September 2008 10 suggests financial markets played an important role in the most recent trade 0 decline. Since the beginning of the –10 financial crisis, banks around the world Capital goods, except automotives have substantially raised their lending Automotive vehicles, engines and parts –20 Consumer goods, except automotives standards. Banks usually finance the Industrial supplies and materials Petroleum –30 purchases of durable goods by house- Foods, feeds and beverages holds and businesses, so tighter lend- Other –40 ing practices have restricted spending, 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 particularly on durable goods. Another often-cited mechanism C. …as Durables Patterns Change from 2001 is the collapse in trade credit—loans provided to importers and exporters to Percent* facilitate global trade. A striking feature 50 40 of the financial crisis is the drop in 30 international capital flows. Private capi- 20 tal inflows and outflows as percentage 10 of GDP in the U.S. fell significantly 0 from 2007 to 2009 (Chart 8). Similar –10 patterns exist in other countries. –20 Durable goods consumption Without steady capital flows, the –30 Investment financing that firms depend on for –40 imports and exports dried up, adding –50 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 to weakening global demand. Trade finance data are generally unavailable, but some evidence of the trade credit *Quarter/quarter, annualized. collapse comes from Brazil, where NOTE: Shaded areas represent recessions. The official end of the current recession has yet to be declared. trade credit flows from foreign inves- SOURCE: Bureau of Economic Analysis. tors fell from more than $20 billion in 2007 into negative territory at the start of 2009 (Chart 9).

EconomicLetter Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas 5 EconomicLetter Major trade finance providers such Chart 8 as Citigroup and HSBC Holdings also confirm that the trade-finance business U. S. Capital Flows Plunge is under significant stress globally.6 Changing production strategies is Percent of GDP another important factor behind the 15 synchronized collapse of international Private capital trade. Companies increasingly make inflows products in sequential stages in several

10 countries to exploit the comparative advantages of each country at different production stages. This internationaliza- tion of production—often called vertical 5 Private specialization—has been increasing over capital time and helps explain the increase in outflows world trade over the past two decades.7 0 Greater vertical specialization can amplify the decline of international trade during recessions.8 Consider two –5 cases—one without and one with ver- 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 tical specialization. Without vertical specialization, NOTE: Shaded areas represent recessions. The official end of the current recession has yet to be declared. country A imports $100 of goods from SOURCE: Bureau of Economic Analysis. country B. If country A’s demand for imports disappears in a recession, total world exports decline $100. With vertical specialization, goods are made in two stages. In the first Chart 9 stage, country A produces intermedi- ate goods and exports them to country Brazil’s Trade Credit Flows Sink B for production of final goods. Then country B exports the final goods back Billions of U.S. dollars* to country A. We further assume that 25 the value of intermediate goods is $50 and the value of final goods is still 20 $100. When country A’s demand disap- Trade credit pears, the loss of total world exports 15 is $150 ($50 from country A to B, plus $100 from country B to A). 10 The amplification effect can

5 become even bigger when the vertical specialization involves more than two 0 countries. So, the percentage declines in real-world trade can grow much larg- –5 er than the recessions that spawn them.

–10 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 More Trade Restraints? Growing job losses during a reces- *12-month moving total. sion usually create the environment

NOTE: Trade credit flow is net of the concession and payment of credits linked to trade in goods and services. In Brazil, it for another damper on international mainly includes short-term trade financing (up to 260 days) that foreign investors granted to Brazilian firms. trade—protectionism. There’s little evi- SOURCE: Central Bank of Brazil. dence that it has played a role in the latest trade collapse, but protectionist pressures are rising around the world.

EconomicLetter 6 Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas EconomicLetter One sign is the increased filing of trade disputes to the World Trade Chart 10 Organization (WTO), the international body that governs global trade. Newly Protectionist Activity Begins to Stir initiated import restrictions by WTO members have steadily risen since the A. New Import-Restriction Investigations third quarter of 2007 as member coun- Number tries seek ways to protect domestic 40 industries from international competi- Developing countries tion. During the first half of 2009, 35 Developed countries WTO members initiated 71 product- level investigations requesting import 30 restrictions, an increase of more than 25 20 percent from the first half of 2008 and 86.8 percent from the first half of 20 2007 (Chart 10A). Today’s protectionism is frequent- 15

ly in the guise of nontariff barriers 10 such as antidumping actions. The most recent global peak came during the 5 2001 recession (Chart 10B). So far, this 0 recession hasn’t seen a similar surge. 2007:Q1 2007:Q2 2007:Q3 2007:Q4 2008:Q1 2008:Q2 2008:Q3 2008:Q4 2009:Q1 2009:Q2 While still at relatively low levels, antidumping measures initiated and imposed began rising in 2008. B. Antidumping Initiations and Other Measures The uptick in trade-protection Number measures since 2008 is worth watch- 400 ing. A lag exists between initiation and Initiations imposition of import restrictions. In 350 Imposed measures

the previous recession, total initiations 300 peaked in 2001, and total imposed antidumping measures jumped the 250 next two years. Higher initiations in 200 2008 and 2009 are likely to result in increased import restrictions in 2010 150 and perhaps beyond. In the second half of 2009, the 100

global economy stabilized and started 50 showing signs of recovery. The return of confidence in global growth has 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 boosted demand for durable goods and, therefore, global trade. With SOURCE: World Trade Organization member actions as reported in the Global Antidumping Database. economic conditions expected to con- tinue improving in 2010, international trade is likely to recover in the coming months. past two decades. The country’s close- may depend on trade-surplus countries However, trade-protection mea- to-zero household saving rate wasn’t boosting domestic consumption. sures expected to be imposed in 2010 sustainable in the long run. During could create more trade frictions and the current recession, the U.S. savings Wang is a senior economist in the Research become a drag on the trade rebound. rate has increased, and the current Department of the Federal Reserve Bank of Dallas. And questions remain about how account deficit has narrowed. If U.S. robust consumption will be. households’ frugality endures, demand Notes The expansion of global trade may remain relatively soft in the near The author thanks Janet Koech for her research was fueled by strong U.S. demand the future. A quick global trade rebound assistance.

EconomicLetter Federal Reserve Bank of Dallas Federal Reserve Bank of Dallas 7 EconomicLetter EconomicLetter is published by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal 1 See World Trade Organization press releases, Control, vol. 32, no. 8, 2008, pp. 2622–50. Reserve System. 6 March 23, 2009, www.wto.org/english/news_e/ For a more extensive discussion on the issue of Articles may be reprinted on the condition that pres09_e/pr554_e.htm#fnt1. trade finance, see “Trade, Globalization and the the source is credited and a copy is provided to the 2 The correlation with gross domestic product Financial Crisis,” by Mark A. Wynne and Erasmus Research Department of the Federal Reserve Bank of Dallas. (GDP) since 1980 is 0.62 for imports and 0.47 K. Kersting, Federal Reserve Bank of Dallas Economic Letter is available free of charge for exports. Economic Letter, vol. 4, no. 8, 2009. by writing the Public Affairs Department, Federal 3 See “International Trade in Durable Goods: Un- 7 For instance, see “The Nature and Growth of Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX derstanding Volatility, Cyclicality, and Elasticities,” Vertical Specialization in World Trade,” by David 75265-5906; by fax at 214-922-5268; or by telephone at 214-922-5254. This publication is available on the by Charles Engel and Jian Wang, NBER Working Hummels, Jun Ishii and Kei-Mu Yi, Journal of Dallas Fed website, www.dallasfed.org. Paper no. 13814, National Bureau of Economic International Economics, vol. 54, no. 1, 2001, Research, February 2008. pp. 75–96, and “Can Vertical Specialization 4 The average correlation is 0.63 between imports Explain the Growth of World Trade?” by Kei-Mu and GDP and 0.39 between exports and GDP Yi, Journal of Political Economy, vol. 111, no. 1, in our dataset of 25 Organization for Economic 2003, pp. 52–102. Cooperation and Development countries. 8 Andrei Levchenko, Logan Lewis and Linda Tesar 5 See note 3. Also see “International Trade and find empirical evidence that durable goods and Business Cycles,” by Marianne Baxter, in Hand- vertical specialization played an important role book of International Economics Vol. 3, Gene M. in the recent trade collapse. See “The Collapse Grossman and Kenneth Rogoff, ed., Amsterdam: of International Trade During the 2008–2009 North–Holland, 1995, pp. 1801–64, and “Trade Crisis: In Search of the Smoking Gun,” University Adjustment and the Composition of Trade,” by of Michigan, Research Seminar in International Christopher J. Erceg, Luca Guerrieri and Chris- Economics Discussion Paper no. 592, October topher Gust, Journal of Economic Dynamics and 2009.

Richard W. Fisher President and Chief Executive Officer

The Euro and the Dollar Helen E. Holcomb First Vice President and Chief Operating Officer in the Crisis and Beyond Harvey Rosenblum Wednesday, March 17, 2010 Executive Vice President and Director of Research Federal Reserve Bank of Dallas Robert D. Hankins Executive Vice President, Banking Supervision

Leading economists and scholars from the U.S. and Europe Director of Research Publications Mine Yücel will gather for a timely discussion about the European Union’s common currency in The Euro and the Dollar in the Crisis Executive Editor and Beyond, a one-day conference March 17 at the Federal Jim Dolmas

Reserve Bank of Dallas. Editor Part of the European Commission’s effort to mark the Richard Alm

euro’s first decade, the conference is cosponsored by the Associate Editor Dallas Fed, the Peterson Institute for International Economics Kathy Thacker and the European economic institute Bruegel. Presenters will review this monumental change in the global economy and Graphic Designer look closely at such topics as the roles of the euro and dollar Ellah Piña and lessons from the response to the economic crisis. The event is open to economists, academicians, policymakers and others with interest in the euro’s evolution. To register, go to http://dallasfed.org/institute/events/10euro.cfm. There is no charge to attend, but registration is required. Federal Reserve Bank of Dallas 2200 N. Pearl St. Dallas, TX 75201