What Explains Excess Trade Persistence? A Theory of Habits in the Supply Chains

51 Pages Posted: 21 Jan 2021

See all articles by Mariarosaria Comunale

Mariarosaria Comunale

Bank of Lithuania - Economics Department

Justas Dainauskas

affiliation not provided to SSRN

Povilas Lastauskas

Center for Excellence in Finance and Economic Research; Vilnius University

Date Written: January 21, 2021

Abstract

International trade flows are volatile, imbalanced, and fragmented across off-shored supply chains. Yet, not much is known about the mechanism through which trade flows adjust in response to shocks over time. This paper derives a dynamic gravity equation from a theory of habits in the supply chains that generates autocorrelated bilateral trade flows that are heterogeneous across different country pairs. We estimate our version of the dynamic gravity equation for 39 countries over the period of 1950-2014 and find that the transmission of local and global trade shocks is fundamentally different. We show that the trade persistence coefficient falls from 0.91 to 0.35 when we depart from the existing empirical gravity models that draw inference from the pooled coefficient estimates without controlling for the variation in the unobservable global factors. Thus, our approach escapes the excess trade persistence puzzle and adds to the explanation of the sharp decline and the rapid recovery of the global trade flows during the “Great Trade Collapse” of 2008-09. In addition to the traditional variables in the gravity equation, we also show that a cross-country habit asymmetry creates bilateral and multilateral trade imbalances, which are an important determinant of bilateral trade flows both theoretically and empirically.

Keywords: Dynamic Gravity Equation, Habits, Trade Persistence, Trade Imbalance, Global Shocks, Parameter Heterogeneity

JEL Classification: C23, F14, F41, F62

Suggested Citation

Comunale, Mariarosaria and Dainauskas, Justas and Lastauskas, Povilas, What Explains Excess Trade Persistence? A Theory of Habits in the Supply Chains (January 21, 2021). CAMA Working Paper No. 11/2021, Available at SSRN: https://ssrn.com/abstract=3770389 or http://dx.doi.org/10.2139/ssrn.3770389

Mariarosaria Comunale (Contact Author)

Bank of Lithuania - Economics Department ( email )

Totoriu 4
Vilnius, LT-01121
Lithuania

Justas Dainauskas

affiliation not provided to SSRN

Povilas Lastauskas

Center for Excellence in Finance and Economic Research ( email )

Totoriu g. 4
Vilnius, LT-01121
Lithuania

HOME PAGE: http://www.lb.lt/cefer

Vilnius University ( email )

Lithuania

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
43
Abstract Views
163
PlumX Metrics