Trade accounting in the recent recession

Jonathan Eaton, Samuel S. Kortum, John Romalis, Brent Neiman, 7 July 2010



As discussed by dozens of researchers in a recently released Vox eBook (Baldwin 2009), myriad factors may have contributed to the changes in the ratio of trade to GDP in countries across the globe. In the eBook, Bergsten writes on the role of deficits and external imbalances. Levchenko, Lewis, and Tesar highlight a disproportionate decline in durable goods sectors, those most important to trade. Evenett reviews protectionist measures linked to the crisis. Our research (Eaton et al. 2010) creates a model in which demand shocks, trade friction shocks (very broadly defined), productivity or preference shocks, and changes in deficits can all play some role in driving global trade patterns. Further, our general equilibrium model allows us to run counterfactuals which quantify the contribution of each factor in isolation.

The model builds on the work of Eaton and Kortum (2002), Alvarez and Lucas (2007), and Deckle et al. (2008). Given the importance of heterogeneity in inter-sectoral linkages, production in our model reflects the country-specific input-output structures found in OECD input-output tables. We merge this structure with a gravity model of trade to ensure that we can actually match the large changes in bilateral trade shares observed during the crisis. Finally, we use information contained in monthly sector-level industrial production and producer price indices to generate monthly production series for more than 20 countries. Combined with monthly information on trade, these data allow us to focus on the key inflection points marking the beginning and end of the recent downturn.

We find that the importance of each shock varies across trading relationships and countries. For example, increases in trade frictions played only a modest role, if any, in most countries. China and Japan, however, experienced increases in trade frictions which, on their own, reduced global trade/GDP by several percentage points. Figure 1 shows the time fixed effects from a regression of Japan's bilateral Head-Ries indices, inverse measures of trade frictions, from the first quarter of 1997 to the fourth quarter of 2009. The decrease in the index in 2008 suggests that trade fell relative to what would be expected just from demand, productivity, or deficit shocks alone. This decline could reflect, for example, difficulties in financing trade as in Amiti and Weinstein (2009), the home-bias implicit in fiscal stimulus, or protectionist measures, among other possibilities.

Figure 1. Durable and non-durable trade frictions in Japan

The decline in the share of the durable sectors in final demand, however, was most striking. This negative durables demand shock exceeded 20% for most countries. See, for example, the sharp decline in durables’ share for the US and South Korea in Figure 2 below.

Figure 2. Durable and non-durable shares in final demand for the US and South Korea

When we run our model in the counterfactual scenario in which we only allow for demand shocks, and hold fixed deficits, trade frictions, and productivities or preferences, we explain more than 80% of the change in global trade/GDP and nearly two-thirds of the cross-country pattern of changes in trade/GDP.

The recent recession perhaps is the most interesting post-war application of our framework, but in future work we intend to use it to decompose trade changes over longer periods of time, in particular during other recessions. While this note focuses on the ratio of trade to GDP, future work will investigate the implications of the model for production, GDP, and other macroeconomic variables.


Alvarez, Fernando and Robert Lucas (2007), “General Equilibrium Analysis of the Eaton-Kortum Model of International Trade”, Journal of Monetary Economics.

Amiti, Mary and David Weinstein (2009), "Exports and Financial Shocks", NBER Working Paper 15556.

Baldwin, Richard (2009), The Great Trade Collapse: Causes, Consequences and Prospects, A Publication, 27 November.

Bergsten, Fred (2009), “The dollar and the budget deficit”, in Richard Baldwin (ed.), The Great Trade Collapse: Causes, Consequences and Prospects, A Publication, 27 November.

Deckle, Robert, Jonathan Eaton, and Samuel Kortum (2008), “Global Rebalancing with Gravity: Measuring the Burden of Adjustment”, IMF Staff Papers.

Eaton, Jonathan and Samuel Kortum (2002), “Technology, Geography, and Trade”, Econometrica.

Eaton, Jonathan, Samuel Kortum, Brent Neiman, and John Romalis (2010). “Trade and the Global Recession”, Working Paper.

Evenett, Simon (2009), “Crisis-era protectionism one year after the Washington G20 meeting”, in Richard Baldwin (ed.), The Great Trade Collapse: Causes, Consequences and Prospects, A Publication, 27 November.

Head, Keith and John Ries (2001), "Increasing Returns versus National Product Differentiation as an Explanation for the Pattern of U.S.-Canada Trade," American Economic Review.

Levchenko, Andrei, Logan Lewis, and Linda Tesar (2009), “The collapse of US trade: in search of the smoking gun”, in Richard Baldwin (ed.), The Great Trade Collapse: Causes, Consequences and Prospects, A Publication, 27 November.

Topics: Global crisis, International trade
Tags: business cycle, global crisis, great trade collapse, international trade

Professor of Economics at New York University

Professor of Economics, University of Chicago

Brent Neiman

Associate Professor of Economics at University of Chicago Booth School of Business

John Romalis is an Associate Professor of Economics at the University of Chicago Graduate School of Business.