Product Durability and Trade Volatility

Petropoulou, Dimitra and Soo, Kwok Tong (2011) Product Durability and Trade Volatility. Globalization and Monetary Policy Institute Working Paper (94).

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Abstract

One of the main causes behind the trade collapse of 2008-09 was a significant fall in the demand for durable goods. This paper develops a small country, overlapping generations model of international trade in which goods durability gives rise to a more than proportional fall in trade volumes, as observed in 2008-09. The model has three goods - two durable, traded goods and one non-durable, non-traded good and two factors of production. The durability of
goods affects consumers’ lifetime wealth and their optimal consumption bundle across goods and time periods. A uniform productivity shock reduces consumers’ lifetime wealth inducing a re-optimisation away from durables. This gives rise to a more than proportional effect on international trade, provided the non-traded sector is sufficiently capital intensive. The elasticity of trade flows to GDP is found to be increasing in both the degree of durability and the size of the shock. The model thus provides microfoundations for the asymmetric shock to the demand for durable goods observed in recessions and clarifies the link between this endogenous shift in preferences and international trade flows. It also explains the observation that deeper downturns are associated with a higher elasticity of trade to GDP. Furthermore, the greater the
degree of durability of traded goods, the larger is the share of domestically produced goods in consumption, for plausible factor intensities. This provides an alternative explanation for the home bias in consumption, and hence another explanation for Trefler’s "missing trade".

Item Type: Article
Schools and Departments: School of Business, Management and Economics > Economics
Subjects: H Social Sciences
Depositing User: Dimitra Petropoulou
Date Deposited: 22 May 2012 09:36
Last Modified: 22 May 2012 09:36
URI: http://sro.sussex.ac.uk/id/eprint/39367
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