World is Flat

Essay Topic Some authors believe that we are moving toward (if not actually achieving) a ‘borderless’ or ‘flat world in which distance is no longer meaningful.

Discuss this idea using models, concepts and data about contemporary system of international trade. Under what conditions might this tendency be realized? What mechanisms are pushing in this direction, and describe countervailing forces, if any. Consider primarily trade in primary and manufactured goods, but also discuss trade in services. Over the last 50 years, international trade has grown at an average rate of about 5. 9% per annum.The ratio of trade relative to output has more than tripled over this time period for the world as a whole. The sum of U. S.

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Imports and exports has risen from 6. 5% Of GAP in 1 960 to about in the early sass’s (Hummel 2007). Due to this rapid increase in international trade, a few economists believe that we are achieving a ‘borderless’ world where distance between countries no longer matters for them to trade goods and services. In a truly borderless world, consumers and producers within a given country would not trade among themselves simply because of a shared national identity (Geologies 1998).Trade barriers such as tariffs would not exist.

The increase in trade over the last five decades can be accounted by globalization which has led to the integration of markets all over the world. This globalization trend has been driven by breakthroughs in transportation, communications, industrial technology and the reduction of trade barriers (Youth 2012). Even though, trade has increased substantially, trade costs still exist and are by no means small. Trade costs take the form of transportation, communication, transaction and cultural costs. The data of trade between U. S.A and Canada has shown that people prefer trading within their own country rather than over the border even if distance is the same. The gravity model does a good job in explaining that distance does matter and trade costs are not even close to get eliminated.

Globalization has definitely made it easier to trade all over the world, but one cannot ignore the trade and distance costs that come with it. A common approach in quantifying the strength of an economy’s ties with the rest of the world is to measure the share of its GAP made up of exchange with other countries (imports and exports).A larger share indicates that a neutron has stronger links to the world economy and that it has a more ‘open’ economy (Geologies 1998). Data of the U. S. Trade in goods and services relative to U.

S. GAP over the years has shown this increase in trade which has led to a more open economy (Table 1). Over 25 years, the merchandise trade has more than doubled (relative to GAP). Service trade has grown faster than merchandise trade. Over the last 25 years, service trade (relative to GAP) has nearly tripled (Geologies 1998). A large percentage of this increase can be explained by the trio-national free trade area between U. S. A Canada andMexico that has been created.

Table 2 shows that merchandise trade (relative to GAP) grew from 2. 3% to 5. 4% (Geologies 1998). This shows that a great proportion of the increase in trade is accounted by the increase in trade in these three nations which are in close proximity to each other. This means that distance does matter and countries prefer trading with countries that are closer to them in order to reduce trade costs. Intuitively in a world of positive trade costs, distance should be affected by distance (Kenny 2013).

This is illustrated by Table 3 which shows that more trade occurs between countries hat are close to each other.This table shows how nearly 40% of North American trade takes place with other North American countries and nearly 70% of Western European trade occurs with other Western European countries. Figure 1 shows that U. S. Trades a lot more with Mexico and Canada even though they are much smaller economies as compared to some Western European economies (UK and Germany). Approximately 23% of world trade (by value) occurs between countries that share a land border (Hummel 2007). This data goes to show that distance exerts a powerful force on how much countries trade with each Other.A big share of trade costs are transportation costs and, in a world of positive trade costs, the cost of transporting goods increases with distance.

The rise in international trade over the last few years can be explained by a reduction in transportation costs. Improvements in the quality of transportation services including speed and reliability have also contributed to the rise in international trade. However, understanding modern changes in transportation costs has turned out to be unexpectedly complex (Hummel 2007). The two most common methods of transporting merchandise relied are air shipping and ocean shipping.Historically, ocean shipping has been the most popular transport method.

Air shipments represent only 1% of the total weight of merchandise trade. However, it has been growing at a rate of 7. 4% per annum.

This can be explained by the sharp decline in the relative cost of air shipping. As seen by Table 4 and Figure 2 the cost of air shipping has declined by an average of 1. 5% per year between 1973 and 1993 (Hummel 2007). This is because of the technological change which includes improvements in wing design, material and most importantly the adoption of et engines which are faster, more fuel efficient and more reliable.On the other hand, the cost of ocean shipping over the years shows a different picture. Improvements in technology such as contraindication, larger vessels and improvements in shipping routes have led to the decrease of shipping costs in some countries.

However, in periods of rapidly rising demand, shipping capacity is scarce and SSH piping prices rise quickly. Figure 3 and Figure 4 show that the cost of shipping has not steadily declined in U. S. And Germany over the last 50 years. In fact, there is evidence Of the cost Of ocean hipping increasing in small time periods as well.This is because of a rise in input costs such as fuel, ship prices and port costs. Oil price shocks in the sass’s had led to an increase in operating costs of 14-18% per annum (Hummel 2007). Thus, there is ambiguous evidence on ocean shipping costs which is fairly stable and even growing according to some data.

As shown from the evidence, trade costs and distance costs have by no means been eliminated and borders very much exist. There has been a compositional shift from ocean shipping to air shipping recently due to its faster speed and liability.Air shipping has become much cheaper per unit but it is still more expensive than ocean shipping in absolute terms which has led to an increase in trade costs as a whole. This means that aggregate distance costs have in fact increased due to this compositional shift (Kenny 2013). Apart from transportation costs, there are a few other costs associated with distance as well. Time-related shipping costs, especially in the case of ocean shipping, are extremely important.

There could be spoiling of perishable goods if not delivered on time. Goods can be damaged or lost in transit due to shingling or bad weather.There could be a loss of the market if the purchaser becomes unwilling or unable to make a payment (Head 2003). Communication costs exist as interactions are harder to perform across distance (Kenny 2013). Informal conversations are possible due to the advancement in technology but sealing a deal is tougher due to the lack of face to face interaction. Transaction costs are also present since trust needs to be established for long distance trade to occur. It is more costly to identify opportunities and find trustworthy partners (Kenny 2013).

Lastly, cultural distance also exists.Distance is associated with larger cultural differences (Head 2003). This can inhibit communication and generate misunderstandings while trying to trade. Transportation costs are minimal for the trade of services. However, these costs persist in the service sector as well. There is often a communication gap when services are offshore, for example, which leads to misunderstanding and inefficiency. Language problems could be present if both the countries speak different languages.

Cultural differences, for example negotiation styles, will exist between the two countries making service trade more costly.All these costs make it evident that we are living in a world of positive trade costs when countries are trading merchandise or services. In 1962, Jan Timbering proposed that Newton’s law of gravity could be used to explain international trade and the distance costs associated with it. Figure 5 shows the gravity model.

Fiji is the trade flow from destination I to destination j. Mi and Ms is the GAP of country I and country j. Dig is the distance between country I and j (Head 2003). Since, distance is in the denominator, it signifies that an increase in distance will lower the amount of trade between two countries.

Taking logs gives us a linear function shown in Figure 6 which was tested to see the fit of the model. Alpha and beta need to be positive and theta negative for this model to work as predicted. The results after running a regression of this linear functions show that the model fits very well with an RE value between 0. 65 and 0. 95 which is very high. About 1 500 distance effects from 103 papers were examined by Disorder and Head. The estimates received for alpha and beta was very close to 1 and the average theta received was 0. 9.

This goes to say that increasing distance by 10% leads to a decrease in trade by 9% (Kenny 2013). Figure 7 and Figure 8 show the predicted (according to gravity model) and actual trade patterns of a couple of Canadian provinces and American states respectively (Head 2003). It shows that the gravity model has done a good job in predicting the trade patterns and clearly shows that the volume of trade decreases as distance increases. The G in the gravity model was initially regarded as a constant and thus unimportant to the model. However, recently economists have considered G as remoteness.Countries with many nearby sources, that is with a lower value of G, will import less from each reticular source. This can be illustrated by the differences in trade between Australia and New Zealand and the trade between Austria and Portugal.

While the gravity model has been extremely useful, it does have some flaws like any other model and relies on certain controls. The distance between each paid major cities is almost the same and the product of their GAP is similar (Australia-New Zealand is 20% smaller). Without remoteness, Austria- Portugal trade should be slightly larger.However, in 1 993 Australia- New Zealand trade was 9 times larger (Head 2003).

This is due to the lack of close y alternatives for Australia and New Zealand due to their remote location. Thus, remoteness does play a major role in determining trade patterns. The gravity model overall does a very good job in predicting trade patterns.

However, like every other model, it does have its drawbacks and assumptions/controls which can be augmented on. Countries that share a border for example have 65% more trade (Head 2003). A dummy variable can be added in order to account for this increased trade in adjacent countries.Countries that share the same language trade twice to three times more than Mounties that don’t (Head 2003). This is because communication is easier and transaction costs are lower. Countries that have a common currency have much more trade.

For example U. S. And Panama have 3 times more trade as compared to the predicted value of the gravity model (Kenny 2013).

Lastly, free trade areas have on average 50% more trade than predicted due to the elimination of trade costs such as tariffs. The gravity model has some assumptions in order for it to work. For example, every country should specialize in a distinct set of products. People in different countries have methodic preferences, that is, people with different incomes demand goods in same proportions. Lastly, exports are equal to imports for all countries (Kenny 2013). Even though the gravity model is not perfect, it is evident through data collected that distance does matter and trade costs increase as distance increases.

The effect of the border on trade can be seen clearly from the trade data of U. S. A and Canada. For example, the gravity model predicts that Ontario and Quebec should export 10 times more to California as compared to British Columbia.

The distance between them are very similar ND Californians GAP is more than ten times greater that British Columbia. However, in 1988, Quebec and Ontario exported more than three times as much to British Columbia as to California (McCollum 1995). Table 5 shows the difference between predicted (according to gravity model) values and actual values of trade between Canadian provinces and U. S. A states.

It is clearly seen that Canadian provinces trade much more than predicted within Canada and much less than predicted to the U. S. A.The effect can be seen by adding a dummy variable to the gravity model. The dummy in the gravity model would be 1 if trade is in the same country and O if it is across the border. As seen in Table 6, the dummy was found out to be 3.

09 (Kenny 2013). After exponentiation, this value translates to 22 times higher trade within the border as compared to across the border. In subsequent research the size of this border effect has been downgraded but it still remains (Kenny 2013). This data and findings show that the border plays a huge role to determine trade patterns between two countries.With the development of the internet, domains from a country can be viewed worldwide by anyone.

However, orders do have an effect on web visits and online purchases of goods and services as shown by data. A 1 % increase in distance leads to a 2. 7% decrease in purchases of goods and services on the internet (Kenny 2013). Taste differentiated goods which vary across cultures and countries have an even stronger effect. These goods include music, pornography and game. Data shows that a 1 % in increase reduces purchases by 3. 5%.

This goes to show that even when there are no trade costs, distance and borders still matter.