US, China, Brexit… it’s all about international trade. But we have to oil the wheels at home too – domestic and export markets should not be seen as separate

March 11, 2019

Trade wars, trade deals, free trade. Everyone is talking about it. Trade experts now warn of trade distortions. New technologies may help, but a new Cebr study reveals other things may also need fixing behind the border.

 

Despite blunt statements from global leaders, the substance of what is being debated mostly concerns the process through which international trade is managed rather than the principle of free trade itself. This is borne out in: 

  • Individual countries making their exports more competitive through currency policy, subsidies or other market interventions, leading to debates regarding the governance of global trade to deal with these distortions.
  • The Brexit debate, dominated by the process question of how the UK’s international trade and economic relationships should be managed. 

 

While such debates are politically heated, the economic gains from liberal global trade are less controversial. Recent Cebr work commissioned by the IEA has sought to illustrate these gains through an Agent Based Model. This approach makes assumptions about process outcomes – but we remain agnostic on the politics about how these outcomes are achieved. The goal is to provide another way of illustrating the benefits of trade, utilising gains through scale.

 

The work is an illustrative first look covering domestic and international trade, hence the results are very generic and need to be interpreted with care. The model aims to illustrate how the output of countries, and in turn global output, is affected by the presence of distortions and frictions. The main results can be summarised as follows:

  • A between-country trade distortion of 25% acts to lower global output by around 4% relative to the benchmark case with no distortions. With a 100% distortion, global output is around 11% lower than in the benchmark case with no distortions.
  • A within-country trade distortion of 25% implies that one quarter of beneficial transactions between consumers and firms within a country are prohibited through distortions, and this acts to reduce global output by approximately 14% relative to the benchmark case with no distortions. Meanwhile, a 50% distortion causes a 25% global output drop.
  • If between- and within-country trade distortions are 25%, global output is approximately 17-18% lower than the benchmark case. Within a relatively simple model the effects are additive rather than interactive.

 

The model makes a number of simplifications concerning labour markets; factor mobility; and intertemporal consumption and production decisions. The full realisation of scale economies may also require de-facto institutional pillars. Furthermore, the model has not explored the other key benefit of trade, which comes through specialisation. The interaction of specialisation alongside scale would potentially be the most fruitful extension of the work.

 

In summary, domestic distortions are shown to be of greater magnitude than international trade distortions. This is intuitive, as economies trade more internally than they do externally. However, both impacts have significant relative effects. This suggests a necessary commitment to multilateral liberalisation in between counties and within countries such that overall barriers are simultaneously lowered.

 

Contact: Cristian Niculescu-Marcu cniculescu-marcu@cebr.com
Phone: +44 (0)20 7324 2866