Why Trade in Services Resisted the Crisis

Results from this blogpost in short:

• Services represent the most dynamic component of developed economies.
• While the 2008/09 crisis affected trade in goods in a major way, trade in services remained relatively unaffected.
• Policy should focus more on services, in order to exploit their comparative advantage and enjoy higher growth prospects and stability.

The 2008-2009 crisis has been one of the deepest recorded since the great depression. It arrived suddenly and unexpectedly: GDP contracted immediately and trade in goods experienced the steepest decline ever recorded, with both exports and imports dropping four times more than income (Freund, 2009; Levchenko, Lewis, & Tesar, 2010). Since then, trade in goods barely rebounded and has almost never grown again more than GDP. This means that since the crisis, trade in goods has not contributed to growth.

Looking at the trade in services side, we can observe that it has been the most important contributor to trade growth in the past fifteen years in all developed economies. Moreover, focusing on the 2008-2009 shock, we can surprisingly appreciate that trade in services was relatively unaffected. Business, telecommunication and financial services -which constitute more than half of trade in services in modern economies- continued growing at their pre-crisis rates and only the category of transport services declined (Borchert and Mattoo, 2009). Moreover, even after the crisis services continued growing more than GDP and only in 2005 did they experience a mild slowdown.

Why is trade in services so resilient? Can trade in services be a way out of the present economic stagnation? In this post I answer these questions by providing a non-technical summary of Ariu (2016). In particular, I describe the reaction of both goods and services exporters to the 2008-2009 crisis using data at the firm level from the National Bank of Belgium.

Firms adjust the volume of traded goods, not the number of trade destinations

The first step in analyzing the 2008-2009 crisis is to decompose exports’ flows at the firm level into the number of countries served, the number of products per destination and the average exports per product-destination. By doing this, we observe that both goods and services exporters reacted similarly to the same shock: firms kept the same number of destinations and products per destination and they just adjusted the average value of their shipments. Despite the qualitative similarity, huge quantitative difference exist: firms exporting services decreased the average value of their exports of only -4%, while those exporting goods of a whopping -27%. The evidence is therefore telling that firms did not destroy their international network, but they just adjusted the size of their shipments. When looking at the product composition of exports, we observe that services related to transport experienced a drop commensurate to that of goods. On the other hand, business, financial and telecommunication services (which represent more than 50% of Belgian services exports) continued their sustained growth. On the goods side, all product categories experienced a decline, yet the bulk of the collapse came from durable and capital goods and the decline was equally spread across all destinations. No significant differences are found for both goods and services when looking at different destinations or regions.

Understanding the causes of the resilience

Both supply and demand determinants could determine the special resilience of services.

On the supply side, we can identify three major forces:

1. Banks reduced the availability of external capital for exporters, thus driving down aggregate trade volumes (Chor and Manova, 2012; Ahn, Amiti, and Weinstein, 2011; Auboin, 2009; and Amiti and Weinstein, 2011). To the extent that service exporters rely less on external trade capital,[1] this can be a reason why services exports did not fall.
2. The international nature of global value chains makes downstream demand shocks propagate through them with magnified upstream volatility due to inventory adjustments (Altomonte, Mauro, Ottaviano, Rungi, and Vicard, 2012; and Bems, Johnson, and Yi, 2011). For example, if a car manufacturer stops buying intermediates because of a slowdown in car sales, the latter causes not only a contraction for the car producer, but also to all the upstream suppliers. This can create a cascade effect that magnifies the downstream demand decrease to all upstream suppliers. Since services are intangible and thus not storable, they might have suffered less from the inventory adjustment process and from the disruption of global value chains.
3. Service exporters might differ from goods exporters in various dimensions (size, productivity, multinational status, etc.) and that might have led to a different reaction of service trade to the same shock.

On the demand side, services might have a different and more resilient demand with respect to goods. For example, due to their intangibility they cannot be stored. This makes firms demand services continuously in order to keep the productive cycle active.[2] If this is the case, their elasticity with respect to income shocks in destination countries should be different from that of goods.

To shed light on the strength of these forces, I use very detailed firm-product-destination export data for Belgium. In particular, I show that the cause of the different reactions is due to a different elasticity of trade with respect to GDP growth in destination countries. More precisely, the negative income shock in foreign markets affected exports of goods (especially exports of durable goods), but did not disturb the growth of services exports. This means that the main factor behind the trade in goods collapse (Behrens et al., 2011; Bricongne et al., 2012; Eaton et al., 2015; Levchenko et al., 2010) did not have any effect on trade in services. This different elasticity had important economic consequences: if goods exports had had the same elasticity to GDP growth as services, their fall during the 2008-2009 collapse would have been only half what was observed. The composition of exports and GDP helps understanding the different elasticity. Exports are predominantly composed of durable goods, which is the product category that dropped the most during the crisis (Behrens et al., 2011; Levchenko et al., 2010). Instead, GDP is mostly composed of services and consumable goods, which remained relatively stable during the crisis (Borchert & Mattoo, 2009). Thus, exports of goods over-reacted with respect to the negative GDP shock in destination countries, while exports of services did not. When focusing instead on the role of supply factors, we find that credit constraints and firm heterogeneity did not affect services differently from goods. Therefore, besides playing a role in explaining the crisis, they are not responsible for the different behavior.

Conclusion

In light of these results, can we consider services as a way to improve the current economic condition? Based on the evidence of the past twenty years, it is clear that services represent the most dynamic component of developed economies. Therefore, it makes sense for developed countries to put more attention on how to exploit their comparative advantage in service activities (Jensen and Kletzer, 2008). Moreover, in light of the results of Ariu (2016), services can reduce the variability of exports during short but deep economic downturns. Therefore, they offer a more stable basis for employment.  In conclusion, the policy side in developed countries should focus more attention to the services side rather than on considering industrialization policies in order to exploit their comparative advantage and enjoy the higher growth prospects and stability of the services sector.

References:

Ahn, J., Amiti, M., & Weinstein, D. E. (2011). Trade Finance and the Great Trade Collapse. American Economic Review, 101, 298–302.

Altomonte, C., Mauro, F. D., Ottaviano, G. I. P., Rungi, A., & Vicard, V. (2012). Global Value Chains During the Great Trade Collapse: A Bullwhip Effect?. CEP Discussion Papers dp1131 Centre for Economic Performance, LSE.

Amiti, M., & Weinstein, D. E. (2011). Exports and Financial Shocks. The Quarterly Journal of Economics, 126, 1841–1877.

Ariu, A. (2016) Crisis-Proof Services: Why Trade in Services Did Not Suffer During the 2008-2009 Collapse. Journal of International Economics, Vol. 98, 138-149.

Auboin, M. (2009). Restoring Trade Finance: What the G20 Can Do. In The Collapse of Global Trade, Murky Protectionism, and the Crisis. London, UK: Richard Edward Baldwin Simon Evenett.

Baldwin, R. E. (2009). The Great Trade Collapse: Causes, Consequences and Prospects. Technical report, CEPR: London, UK.

Bems, R., Johnson, R. C., & Yi, K.-M. (2011). Vertical Linkages and the Collapse of Global Trade. American Economic Review, 101, 308–12.

Borchert, I. and Mattoo, A. (2009). The Crisis-Resilience of Services Trade. The Service Industries Journal, 30(13):2115–2136.

Behrens, K., Corcos, G., & Mion, G. (2011). Trade Crisis? What Trade Crisis? The Review of Economics and Statistics, 95, 702–209.

Bricongne, J.-C., Fontagné, L., Gaulier, G., Taglioni, D., & Vicard, V. (2012). Firms and the Global Crisis: French Exports in the Turmoil. Journal of International Economics, 87, 134–146.

Chor, D., & Manova, K. (2012). Off the Cliff and Back? Credit Conditions and International Trade during the Global Financial Crisis. Journal of International Economics, 87, 117–133.

Eaton, J., Kortum, S., Neiman, B., & Romalis, J. (2015). Trade and the Global Recession. American Economic Review, forthcoming.

Francois, J. F. and Woerz, J. (2009). Follow the Bouncing Ball – Trade and the Great Recession Redux. In Baldwin, R.E., editor, The Great Trade Collapse: Causes, Consequences and Prospects. CEPR, UK

Freund, C. (2009). The Trade Response to Global Downturns: Historical Evi- dence. Policy Research Working Paper Series 5015 The World Bank.

1. Bradford Jensen & Lori G. Kletzer (2008). “Fear” and Offshoring: The Scope and Potential Impact of Imports and Exports of Services. Policy Briefs PB08-1, Peterson Institute for International Economics.

Levchenko, A. A., Lewis, L. T., & Tesar, L. L. (2010). The Collapse of Interna- tional Trade During the 2008?09 Crisis: In Search of the Smoking Gun. IMF Economic Review, 58, 214–253.

[1] First, this can be related to the fact that many services can be traded over the internet, thus reducing the need for external finance to make the necessary investments to be able to export (Borchert & Mattoo, 2009). Second, payments are faster for services: production and consumption often coincide (this is especially true for modes 2, 3 and 4 defined in the GATS) and the risk of shipping delays is very low. As a result, the working capital needed to support the firm from production to delivery is lower. Moreover, this lack of payment delays lowers the need of export finance insurance. Third, service exporters might not be able to ask for external trade capital and may be used to work without it. This is because services are intangible and highly customized. Thus, they have little value outside the seller-buyer link and they can hardly be used as collateral.

[2] Services like call center, maintenance or cleaning services must be constantly purchased in order to avoid any stop in the production.