Can Global Uncertainty Promote International Trade?



Isaac Baley, Laura Veldkamp, Michael Waugh | Journal of International Economics

Common wisdom holds that uncertainty impedes trade—yet we show that uncertainty can fuel more trade in a simple general equilibrium trade model with information frictions. In equilib- rium, increases in uncertainty increase both the mean and variance in returns to exporting. This implies that trade can increase or decrease with uncertainty, depending on preferences. Under general conditions on preferences, we characterize the importance of these forces using a sufficient statistics approach. Higher uncertainty leads to increases in trade because agents receive improved terms of trade, particularly in states of nature in which consumption is most valuable. Trade creates value, in part, by offering a mechanism for risk sharing, and risk sharing is most effective when both parties are uninformed.

Information frictions are often invoked as reasons for low levels of international trade. But in an equilibrium model, the link between information friction and trade volume is not simple. Our model shows how information also changes the expected terms of trade. It also highlights that in the face of risk, some types of agents may prefer to export more to ensure that they have a sufficient amount of the foreign good to consume. This depends on agents’ preferences.

With constant elasticity of substitution (CES) preferences, information frictions impede trade when goods are very substitutable. The decline in trade occurs because the increase in risk from lower-precision information deters trade, and that risk effect is stronger than the effect on the mean terms of trade, which encourages exporting. But with empirically plausible elasticity param- eters, the opposite is true: Information frictions encourage trade. CES preference is not a special or anomalous case. We derive a a broad class of preferences for which similar effects arise.

Our results demonstrate that, if we believe that information frictions are truly an important barriers to international trade, we need to amend standard trade models to be consistent with this belief. The could mean changing the elasticities or types of pref- erences used, adding new frictions that interact with information, or finding some way to change the relationship between uncertainty and the expected terms of trade.

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