Breaking Down World Trade Elasticities: A Panel ECM Approach

Abstract

This paper exhaustively analyses the recent decline of international trade elasticities to output growth. We extend an empirical model of import demand functions to account not only for transitory factors, such as relative prices and import intensity-adjusted measures of demand (I-O Tables), but also for habitually neglected permanent factors such as protectionism, vertical integration (i.e. Global Value Chains) and foreign direct investment (FDI). Dealing with a non-stationary heteregenous panel of 27 countries, we estimate a panel Error Correction Model from 1960 to 2015 in order to break down world trade elasticities. Our main findings evidence: i) the presence of panel (cointegrating) structural changes in the trade-to-GDP relationship in 2000 and 2009, private consumption being a source of disruption; ii) although investment and exports are the most sensitive, import-intensive components of demand, this is far from being transitory, which is clearly weighing on the current slowdown; iii) the relevant contribution of GVCs shows a procyclical pattern, questioning the permanent nature of the current levelling-off of vertical integration processes. The lack of progress in reducing import tariffs and the usual discarded, complementary relationship between FDI and imports have a residual role. All in all, our results have substantial policy implications, as they reinforce the idea of a historical break towards a new ‘normal’ trading phase.