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NEW YORK – Since the end of World War II, economists have largely followed economic approaches based on the expectation that global uncertainty impedes international trade – especially when uncertainty spans multiple countries. But as the world confronts a trifecta of calamities that include a global health crisis, geopolitical tensions, and low economic growth, that theory is being put to the test. In the last year alone, a trade deal between the U.S., Mexico, and Canada has gone into effect and the United Kingdom finalized a trade pact with the European Union to complete its Brexit negotiations. According to new research from Columbia Business School, higher trade activity and global uncertainty may not be so discordant, as new data shows that the “unknown” can lead to improved negotiations if countries are pursuing the goal of higher consumption and trade better distributes risk.
“We’ve always assumed that risk was one of the main barriers to trade, but our research looks at some of the models that economists usually look and we found that uncertainty can actually entice countries to trade more cross border,” said Laura Veldkamp, Professor of Finance at Columbia Business School. “For example, If I’m a U.S. car manufacturer, but the car doors come from Mexico and that country has a new government coming in next month that the market isn’t sure about, that could lead to a spike in car door sales.”
In the study Might Global Uncertainty Promote International Trade?, Veldkamp and her co-authors, Michael Waugh, Professor of Economics at New York University and Isaac Baley, Assistant Professor of Economics at Universitat Pompeu Fabra examined a two goods, two-country Armington model in which both countries produce what the other one needs. As part of their analysis of the equilibrium trade model, they introduced cross-country uncertainty “shocks” that affect the countries’ export choices.
While the study notes the traditionally held belief that uncertainty deters exports, it also finds that high uncertainty can actually result in more volatile terms of trade, making exporting more lucrative. The researchers also find that information can change expected terms of trade and that in the face of risk, some countries prefer to export more to ensure they have a sufficient amount of a foreign good to consume before it’s no longer readily available.
“Trade is good, but more of it isn’t always an indicator that the economic climate is better. When uncertainty is high, people are worse off. It’s tougher for individuals to make purchasing decisions and businesses to know many people they can hire under those conditions,” said Veldkamp. “As human beings, we dislike risk and uncertainty, but we still might trade more even when things aren’t going well.”
To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.
About the researcher
Laura Veldkamp is a Professor of Finance at Columbia University's Graduate School of Business and a co-editor of the Journal of Economic Theory...Read more.