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Strategic
Trade Policy
Gains from
countertrade
Since the mid-1970s,
`countertrade', whereby an exporter agrees to future purchases of
products from the importing country proportional to the original value
of its exports, has grown rapidly, and according to some estimates it
now represents 10-20% of world trade. Countertrade has traditionally
involved mostly countries with serious foreign exchange shortages, and
it has therefore played an important role in East-West trade and in
trade with developing countries.
In Discussion Paper No. 413, Research Fellow Dalia Marin and Erwin
Amann argue that countertrade can be best understood not as a means
of enabling these countries to overcome their foreign exchange
constraint, but rather as a second-best outcome in the absence of
complete futures and insurance markets. The foreign debt and hard
currency shortages faced by Eastern countries and LDCs have become
particularly acute since the 1970s, and Marin and Amann attribute the
increase in countertrade to their increased risk aversion (due to the
tightness of the foreign exchange constraint), which creates the
incentive for countertrade as an alternative insurance contract.
They develop a model of optimal risk-sharing to determine the duration
of countertrade contracts, the extent of price adjustment over time and
the share of production insured, and they establish the conditions under
which gains from countertrade are to be expected. They also use a
comparative static analysis of changes in the amount of risk and risk
aversion to explain the increase of countertrade in world trade observed
since the mid- 1970s, before finally studying the factors that determine
complete insurance of price and output and discussing the possible
welfare implications of this type of trade.
Their results indicate that in the absence of speculation there will be
long-term contracts extending over the total gestation period of the
investment, and that the gains from risk-sharing are maximized at the
longest possible contract horizon. Further, the long-term agreement is
more likely to be a `fixed-price contract' the smaller is the risk
involved; the more the two parties differ in their attitude towards
risk; and the larger is the monopoly power of the `Western' firm.
They show that there are sources of gain from countertrade, first
because the division of risk between two parties reduces its aggregate
cost, and second because part of that risk is transferred to the
`Western' firm, which is better able to bear it. This gives rise to the
possibility of profitable exchange. Because of the substantial reduction
in the aggregate cost of risk, countertrade may lead to accelerated
investment and thus promote growth through export-led stability.
Further, investments that would otherwise not be profitable may become
so under countertrade because of its linking together of the export of
the output and the provision of the insurance. Finally, their
comparative static analysis shows that the increased share of
countertrade in world trade observed since the mid-1970s may be
attributed to an increase in risk aversion of the CPEs/LDCs in the face
of a tight foreign exchange constraint.
Long-Term Contracts in International Trade
Erwin Amann and Dalia Marin
Discussion
Paper No. 413, June 1990 (IT)
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