The great trade collapse and trade imbalances

Richard Baldwin, Daria Taglioni, 27 November 2009



The global crisis has been accompanied by an unprecedented collapse in world trade. The emerging consensus is that this was a demand-driven collapse. The nature of the demand shock, however, was somewhat special. The ultimate source, we believe, was the unsteady and ill-explained policy actions by the US in the events surrounding the Lehman Brothers bankruptcy. This produced an immediate panic in global short-term credit markets; overnight lending among banks dried up. This turmoil, which was not instantly observable to the general public, soon tumbled over into other financial markets. Stock markets plummeted, corporate debt issuances evaporated, and credit markets of most descriptions became dysfunctional.

As consumers, firms and investors around the world watched their TV and computer screens, the world’s pundits discussed what capitalism without the capital might look like. Policy makers eventually stepped up to the challenge and engaged all the tools of government policy that have fixed past banking crisis (bank nationalisations, deposit guarantees, purchase of bad assets, recapitalisation, forced mergers, etc.). But the damage to confidence was already done. The world had suffered “sudden financial arrest”, as Ricardo Caballero called it in his recent IMF speech (Caballero 2009).

The upshot was a global and synchronised “fear of the unknown”, also known as Knightian uncertainty; people just did not know what was happening. To be on the safe side, they waited. They postponed purchases and investments, and other things that could be put – everything ranging from taking holidays to changing jobs.

As far as trade was concerned, this Lehman’s-induced wait-and-see reaction acted as a massive and globally synchronised drop in the demand for “postponeable” goods and services.

As it turns out, most of world trade is composed of postponeables, so the demand shock manifested itself as a sudden, severe and synchronised trade collapse. While the “financial crisis” or “subprime crisis” had been percolating since August 2007, the effects were not felt until October and November 2008. Each of the 104 nations on which the WTO reports data saw their imports and exports fall during the second half of 2008 and the first half of 2009. Tellingly, most of the these nations have banking and financial sectors that are far too “primitive” to have been involved in any of the financial follies that brought down Lehman and all the other North-Atlantic financial titans. For these nations, the trade collapse arrived with the label: “Made in New York”.

The trade and production collapses

Table 1 shows the total drop for the world and a selection of nations and regions. Most are in the range of 25% to 30%. The table also shows the month with the lowest record value of trade since the crisis began. These facts show that the recovery has begun. The collapse bottomed out in May 2009 for most of the rich nations and earlier for Asian emerging markets.

For comparison, the table also shows the declines in industrial production. We see that the trade drop was sensibly higher and more sudden than the fall in industrial production. World industrial production fell by 13% between April 2008 (its relative peak) and March 2009 (its nadir). The world trade contraction from peak-to-trough was faster paced (8 months) and deeper (25%) than the industrial-production fall.

This pattern of trade falling deeper and faster than industrial production is seen in every country. In emerging economies the divergence was particularly striking; the drop in industrial production was equal to 9% and spread over a period of 7 months, while the trade fall was three times bigger (28%) and took as little as 3 months to materialise; differences for individual countries are even more striking.

As much of GDP involves output that was unaffected by the fear factor (services, etc.), the falls in GDP were greatly mitigated compared to the industrial production figures.

Table 1. Rates of contraction from peak to trough, 2008-2009


Source: Authors’ calculations using CPB data; Cumulative change is calculated from peak to trough observation (i.e. differs from country to country)

Impact on global imbalances

The rapid collapse of trade between the third quarter of 2008 and the first quarter of 2009 improved most balances of trade. It could not have done otherwise. As a matter of pure logic, a rapid fall in both imports and exports produces an equally rapid drop in the absolute gap between them.

Figure 1. Recent improvements in global imbalances


Source: IMF, World Economic Outlook, online database.

The result is clear from Figure 1. The deficit nations like the US and the UK saw remarkable improvements as did the surplus nations, especially Japan.

The great trade collapse was not the sole driving force behind the improvements. There has been some adjustment especially in China, Japan and the US. But as Table 1 illustrates, regardless of any fundamental changes, a large measure of the improvements must be due to the trade collapse.

More detail on the biggest imbalance nations

To get at these issues, we turn to monthly data from the WTO (this data is not adjusted for seasonality or inflation). We start with the two largest imbalance nations – the US and China (Figure 2).

Figure 2. US and Chinese trade balance, 2008 to most recent

Note: Goods ($ billion)

Source: WTO online database.

The trade collapse for the US meant a rapid fall in both its exports and imports, but a more rapid fall in its imports. The result – as is clear in Figure 2 – was a spectacular improvement in the monthly trade deficit. From a peak of almost $100 billion in July 2008 (shown as 07-08 in the chart), the monthly deficit dropped to just $30 billion in February 2009. Since then however it has been rising again. The latest data, for August 2009, indicate that it is back up at about $50 billion, about half way back to its pre-crisis high. The source of the deterioration is not merely an equiproportionate growth in imports and exports. The chart shows that US imports dropped faster and farther than exports, but the recovery in imports is also faster.

The right panel of Figure 2 shows the trade and trade balance of China and Hong Kong. We combine the two since many of China’s exports and some of its imports are channelled through Hong Kong. The figures echo the US story but on the surplus side. The trade collapse lowered China’s trade balance in a mechanical fashion (both flows fell, so the difference fell as well). For China, there also seems to have been some adjustment since its exports fell more than its imports up until February 2009. Since that month, however, Chinese trade has recovered rapidly with exports growth somewhat faster. This has turned the monthly balance from approximately zero in February 2009 to about $20 billion in October 2009 – about half way back to its pre-crisis high, as in the US case.

Figure 3. Japanese and EU27 trade balance, 2008 to most recent

Note: Goods ($ billion)

Source: WTO online database.

Germany’s trade balance (not shown) also improved with the trade collapse. From a 2008 peak of $30 billion, the surplus fell to under $10 billion. As trade has recovered, the surplus is well on its way back to its 2008 high. The latest figure (August 2009) show it at about $15 billion.

Looking forward

The great trade collapse was primarily driven by a sudden, synchronised and severe drop in demand. This suggests that trade may recover rapidly as demand recovers. Indeed, as we have already seen, trade has been on the mend since mid-2009, as Figure 6 shows.

The charts show the path of the collapse and recovery in the 2001 downturn and the current one. We see that today’s collapse was much larger for all the nations shown (US, Japan, Eurozone and Emerging Asia), but the shape of the recovery is broadly similar. The recent collapse bottomed out at the end of 2009Q2 for the advanced nations and a quarter earlier for Emerging Asia. The notable exception is Japan; the collapse from fall 2008 was far steeper and far deeper than the 2001 drop. Japan’s export recovery has also been much steeper.

Figure 4. Collapse and recovery, real exports, 2001-‘02 vs. 2008-’09

Note: Real exports, seasonally adjusted, indexed to equal 100 at September 2008; EZ is Eurozone.

Source: Source: CPB database.

In conclusion, it seems that the “Great Trade Collapse” may be turning into the “Great Trade Revival”. How will recovery affect global imbalances? One thing is clear, regardless of any domestic and real exchange rate adjustment that may occur, trade gaps will grow if trade recovers rapidly. A key question is: How fast will trade recuperate?

History is one source that can guide us. All the post-war trade collapses have been followed by very rapid recoveries in trade flows, as Figure 5 shows. The chart plots the three postwar trade collapses. In the 1982 and 2001 episodes, trade returned to its pre-crisis level in two or three quarters after the nadir; the 1975 crisis took four quarters. The figure also plots the track of world imports during the great trade collapse.

Figure 5. Historical trade collapses and recoveries


Source: Authors’ calculations on OECD real monthly trade data (online data base).

Using the mean of these historical adjustment paths, and assuming that the demand recovery follows the pattern of previous recoveries, we can provide a tentative simulation of the future evolution of world trade in the next few quarters. If 2009Q2 turns out to be the nadir – as the monthly data suggests – world trade may be back to its 2008Q2 level by 2010Q1 or Q2. To work out this point more concretely, we use the fitted trade collapse from the three post-war episodes to simulate the path of exports and imports for the world’s main trading nations.

Figure 6 shows the results of the simulations for some big traders. Note that in order to compare the current collapse with previous episodes, we need to use real trade data. Such data are not available for all nations on a monthly basis back to 1974, so we use quarterly data. Unfortunately the third quarter of 2009 was not available from the data source used (the OECD) when this chapter was finalised.

Figure 6. Simulated recovery of exports and imports

Source: Authors’ calculations.

Simulated trade imbalances implied by these figures are shown in Figure 7. These numbers are very rough and ignore any major structural and real exchange rate adjustments that might change their course. Nevertheless, they tell a very clear story. The global collapse of trade – most nations’ imports and exports falling by 25% or more – led to a rapid improvement in trade imbalances according to a logic as irresistible as arithmetic.

Since the trade shut-down was not due to supply-side shocks that might hinder a rapid recovery, it is a good bet that trade flows – both imports and exports – will regain their pre-crisis growth rates as the world’s economy is nursed back to health. The trade gap deteriorations that this will create will be as ineluctable as the improvements we saw last year. The trade rebound will be far from the only factor guiding imbalances, but in the coming quarters it is likely to be one of the most powerful – assuming the economic recovery continues.

Figure 7. Simulated trade gaps with rapid trade recovery

Source: Authors’ calculations.

Macroeconomics and supply chain trade

Some of the key factors behind the great trade collapse point to a change in trade’s role in macroeconomics. International supply chains have changed the nature of international trade and its role in the transmission of shocks. It has blurred the distinction between supply and demand. Consider for instance a fall in UK spending on cars assembled in Slovakia. It not only lowers Slovakian exports, but also the trade in parts and components that come from many other countries and sectors. According to the Deutsche Bundesbank (2009) a fall in car sales is accompanied by a 2.2 times higher fall in purchases (and therefore both imports and exports) of inputs from many other sectors ranging from casting of metals to electrical engineering, chemicals as well as many services sectors.

The old Keynesian world – where my imports depend on my GDP and my exports depend upon your GDP – is gone. Much of the world’s imports are intermediate inputs into exports, so foreign demand – especially in the great buyer markets (US and EU) – determine many nations’ exports and imports. This has several implications for macroeconomic transmissions.

Since Keynesian aggregate demand depends on net exports, the simultaneous collapse in virtually every nation’s imports and exports had much less impact on aggregate demand than the nominal figures might suggest to an economist with the old Keynesian model in mind. In the old Keynesian world, the fall in Japan’s exports by 60% would have been considered catastrophic. In today’s world, the sharp export fall causes a sharp import fall – not via incomes and budget constraints, but via the input-output matrix.

Moreover, the supply chains have quickened the trade transmission channel since trade no longer works its way through an old-fashioned “J-curve”; manufacturing trade flows are more like conveyor belts connecting the various production bays of a global factory. When final sales fall off, the whole factory slows down in synch. The sharper connections should, for example, increase the correlation of hours worked in related industries in different nations – say the auto industry in Japan and Malaysia or Thailand.


The global crisis has been accompanied by an unprecedented collapse in world trade. It is mostly a demand side phenomenon. Looking forward, it is to be expected that imports and exports will recover along with the recovery of global demand.

This trade growth is likely to bring back the large global imbalances observed in recent years. The balance of two factors will govern the outcome in the medium run:

  • Structural changes necessary to rebalance trade accounts.

The US has seen its private savings rise and the dollar fall. However, Chinese spending growth seems largely driven by government stimulus spending – a force which is unlike to affect a long-term shift in domestic absorption. Moreover, as the renembi is pegged to the dollar and the dollar is depreciating, the necessary effective exchange rate appreciation is not occurring – just the opposite.

  • Rapid export and import growth, that will worsen trade accounts.

As we showed, trade flows have already started to pick up. Just as the fall in trade far exceeded the fall in income going into the trade collapse, the rise in trade is likely to far exceed the rise in incomes. If this holds, the recovery will be rapid.

Given a rapid expansion of imports and exports, the trade recovery operates immediately to expand imbalances, but structural adjustments typically work at a pace measured in years rather than quarters, it seems likely that the bigger-imbalance forces will win the race in the next few quarters – assuming the economic recovery continues.


Baldwin, Richard and Daria Taglioni (2009) “The illusion of improving global imbalances” Voxeu, 14 November.

Bricongne Jean-Charles, Lionel Fontagne, Guillaume Gaulier, Daria Taglioni and Vincent Vicard (2009) “Firms and the crisis: French exports in the turmoil” and VoxEU, 5 November 2009.

Caballero, Ricardo (2009). “Sudden financial arrest,”, 17 November 2009.

Deutsche Bundesbank (2009) “The macroeconomic repercussions of a decline in demand for cars, taking into account the intersectoral integration of production”. Monthly Bulletin (February issue), pp. 46-47.

Eaton Jonathan, Sam Kortum, Brent Neiman, John Romalis (2009) “Trade and the Global Recession”, Internet file dated October 2009.

Eichengreen, Barry and Kevin O'Rourke (2009), “A Tale of Two Depressions,”, 6 April.

Freund, Caroline (2009), “Demystifying the trade collapse”,, 3 July.

Krugman, Paul (2009), “World out of balance”, New York Times 16 November.

Topics: International trade
Tags: global imbalances, great trade collpase

Professor of International Economics, Graduate Institute, Geneva; Director of CEPR; Editor-in-Chief

Senior Economist at the World Bank