VoxEU Column Economic history International trade

Explaining two trade busts: Output vs. trade costs in the Great Depression and today

Trade has declined massively during the crisis. This column assesses the relative roles of falling demand and rising trade costs in explaining the collapse and compares it to the Great Depression. Surprising, the increase in trade costs today is as large as in 1929, despite the absence of any modern protectionism resembling Smoot-Hawley. It appears that reviving global demand alone will be insufficient to revive world trade.

If the world economy is now in “purgatory,” as Paul Krugman recently suggested on a TV talk show, global trade has gone to hell and not yet returned. Between July of 2008 and February of 2009, nominal world trade plummeted by 42%. Understanding the cause of this plummet is critical when assessing whether changes in trade policy are needed to revive trade or whether trade will make a “natural” recovery as global demand recovers (Francois and Woerz 2009).

Eichengreen and O’Rourke (2009) show that the recent trade drop is much more severe than that of the Great Depression. This column presents new information on the relative roles of demand and trade costs in explaining the recent trade bust and compares these to the trade bust coinciding with the onset of the Great Depression.

Possible reasons for the trade slump

There is no consensus yet on whether the recent trade bust can be explained by output declines alone, or if there has been a concomitant rise in trade frictions associated with the financial crisis and the drying up of trade credit. Freund (2009) has suggested that world trade has become more sensitive over time to output movements. Hence, a large trade drop could be expected in the midst of this rather severe global recession. Eichengreen and O’Rourke (2009) compare the Great Depression to the present and point out that industrial production declines have been as large or larger in the recent recession, especially for major exporters of consumer durables such as Germany and Japan. With a large elasticity of consumer-durable-intensive trade with respect to output, this has the potential to account for the recent unprecedented post-war trade bust.

At the same time, Yi (2009) suggests that as vertical specialisation has increased in the recent decade, trade has become much more sensitive to changes in the costs of international trade. The resurgence in protectionism and the drying up of trade credit associated with the financial meltdown could also trigger a large fall in trade (Eichengreen and Irwin 2009; Baldwin and Evenett 2009). The steep decline in nominal trade has also been attributed to a collapse in the prices of heavily traded commodities (as emphasised by Francois and Woerz 2009). Indeed, the US import price deflator index dropped 21% from Q3 2008 to Q1 2009 – a drop which is mild next to the 36% fall of the price of Japanese imports. The list of suspects for the recent trade bust is long.

Gravity and trade costs in theory

In recent research we explore a structural model of bilateral trade (Jacks, Meissner and Novy, 2009). This model suggests a precise way to measure the relative contribution of increasing trade costs and declining output to the trade bust. Bilateral trade (the product of exports in both directions) is a function of country-pair domestic trade (itself a function of total output) as well as bilateral trade costs or trade frictions. Trade costs make goods sold abroad relatively more costly than the same goods sold at home. Factors driving these price differentials include tariffs, international shipping costs, non-tariff barriers, trade finance costs and many other such frictions. The benefit of our model is that we can gauge the relative contributions of each of these two factors in a theoretically appropriate way. We rely on GDP-weighted averages of trade, output declines, and trade cost increases.

Trade costs have risen nearly as much as in the first year of the Great Depression

First, we focus on the evolution and contribution of trade costs. Figure 1 tracks an index of the tariff equivalent of trade costs in the first year of the Great Depression and for the recent bust so far. The base is the second quarter of 2008 and data run through the first quarter of 2009. For the Great Depression, we index relative to 1929 values and look only at 1930 using annual data. The samples consist of pairs formed by 27 countries (note China is not included in the sample, but results for the present are similar with its inclusion). The main results:

  • Trade costs seem to have risen only slightly less in the bust of 2008-2009 compared to the Great Depression.
  • In both periods, the tariff equivalent of barriers to trade rose on average roughly 5% to 6% in the first year of the downturn.

Figure 1. The rise in trade costs: The Great Depression vs. 2008-2009

Source: Jacks, Meissner and Novy (2009)

The implication of this finding – combined with some historical knowledge – is important. The measured trade-cost rise is estimated to be similar in the two events, yet tariffs have not risen in today’s crisis in anywhere near the extent to which they did in the 1930s. This seems to indicate that a good fraction of today’s trade drop is due to non-tariff trade policy and other trade frictions – e.g. evaporating trade credit, credit constraints in the market for consumer durables, and other reported changes in policy have been of equal magnitude (see Ferrantino and Larsen 2009 on the latter).

The best evidence we have on new trade barriers, the Global Trade Alert initiative, does not suggest a rise in measured protectionism anywhere near that observed in the 1930s. There must be something else driving the rise in trade frictions. Perhaps the protection is so murky that even GTA cannot document it? Perhaps the trade credit problem is the culprit and thus more important than many argue (Chauffour and Farole 2009)?

The importance of the output slump is greater today than in the Great Depression

Second, the impact of the output slump relative to the rise in trade barriers can also be ascertained using our structural gravity model of trade. Bilateral exports decline one-for-one with demand in our model. Demand is proxied by GDP minus exports, which is a proxy for total production less shipments abroad. Table 1 shows that the output slump explains 47% of the recent trade slump. This is a much larger proportion than 80 years ago. Between 1929 and 1930, the entire drop in trade is explained by a rise in trade costs. Looking only at output movements to understand changes in world trade, one could conclude, contrary to recent findings by Freund, that trade was more sensitive to changes in output during the Depression than it is today.

Table 1. Decomposing Two Trade Busts: 2008-2009 vs. The First Year of the Great Depression

Source: Jacks, Meissner and Novy (2009)


In contrast to the corresponding stage of the Great Depression, the free fall in world trade appears finally to be ending. Our results suggest that a resurgence of global demand will be an important driver of the comeback in global trade. However, to fully revive world trade, significant restrictions and impediments to cross-border trade will also have to be rolled back.

In future research, we will aim to assess how much of the rise in trade costs between 2008 and 2009 was due to tariff changes, financial frictions, and other observable barriers to trade. Such information should be valuable for those seeking to understand how to revive global trade and how to avoid yet another trade bust in the future.


Baldwin, Richard and Evenett, Simon (2009), “The collapse of global trade, murky protectionism, and the crisis: Recommendations for the G20” VoxEU.org, 5 March.

Chauffour, Jean-Pierre and Thomas Farole (2009), “Trade finance in crisis”, VoxEU.org, 5 September.

Eichengreen, Barry and Doug Irwin (2009), “The protectionist temptation: Lessons from the Great Depression for today” VoxEU.org, 17 March.

Eichengreen, Barry and Kevin O’Rourke “A Tale of Two Depressions” VoxEU.org, 1 September.

Ferrantino, Michael J. (2009), “The Global Trade Contraction: How Much is 2008-09 Like 1929-33?” USITC Executive Briefings on Trade, April.

Ferrantino, Michael J. and Amy Larsen (2009), “Transmission of the global recession through US trade”, VoxEU.org, 29 August.

Francois, Joseph, and Julia Woerz (2009), “The big drop: Trade and the Great Recession” VoxEU.org, 2 May.

Freund, Carolyn (2009), “Demystifying the Collapse in Trade“ VoxEU.org, 3 July.

Jacks, David, Christopher M. Meissner and Dennis Novy (2009), “Trade Booms, Trade Busts, and Trade Costs”. NBER Working Paper 15267.

Yi, Kei-Mu (2009), “The collapse of global trade: The role of vertical specialisation,” in Baldwin and Evenett (eds), The collapse of global trade, murky protectionism, and the crisis: Recommendations for the G20, a VoxEU publication.

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