2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, 2008 Globalization, Trade in Middle Products, and Relative Prices Ulrich Kohli Alternate Member of the Governing Board Swiss National Bank

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Three important developments thought to be linked to globalization: the falling labor share in GDP (from about 66% in 1970 to 61% 2005) the increase in openness (from about 5% in 1970 to 13% in 2005) the increase in the trade deficit (from close to zero in 1990 to 6% in 2005)

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 1

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 2

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 3

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Conventional analytical framework: labor share: production theory (factor endowments, technological change, …) openness: consumer theory, macro theory (relative prices, income, …) trade balance: consumer theory, macro theory (income, real exchange rate, …)

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Shortcomings of the Fleming-Mundell model: exports are demand determined (Keynesian view) only two goods in the model: hence, there is no difference between the terms of trade and the real exchange rate

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Shortcomings of the Heckscher-Ohlin model: only two goods (no role for the real exchange rate) all trade in end products

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, In the small open economy: exports are supply determined → production theory All trade is in middle products import decisions made by firms → production theory Thus, the proper setting to analyze openness and trade deficits is production theory

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Real GDP vs. real GDI if trade takes place in middle products, then trade takes place during production changes in the terms of trade and in the real exchange rate impact on real value added these are similar to a technological change Hence real GDI is the appropriate measure of real value added

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, The changes in all three shares can be explained by changes in: the terms of trade the real exchange rate relative factor endowments technology

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, The model: two factors: labor (L) and capital (K) two middle products: imports (M) and exports (X) one final, nontraded good (N)

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 4

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 5

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, 2008 Three-Good Production Possibilities Surface for Alternative Domestic Factor Endowments Figure 6

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 7

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Table 2 Cumulated effects of changes in the terms of trade, the real exchange rate, capital intensity, and technology on openness, the trade balance and the labour share 1970–2005

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, The increase in openness is due foremost to technological change The increase in capital intensity, the deterioration in the terms of trade and the real appreciation of the currency worked in the opposite direction

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, the worsening of the terms of trade 2.the increase in capital intensity 3.the real appreciation of the currency Technological change contained the deterioration The deterioration of the trade balance is due to (in the order of importance):

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, the worsening of the terms of trade 2.technological change 3.the real appreciation of the currency The increase in capital intensity contained the fall The fall in the labor share is due to (in the order of importance):

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17,

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Figure 8

2008 World Congress on National Accounts and Economic Performance Measures for Nations, Washington DC/USA, May 12-17, Conclusions: Recognizing that trade is in middle products has far reaching consequences for the measurement of real value added and productivity, and for the modeling of international trade Technological change has been a major force in the changes that have taken place in recent decades, be it in terms of openness, trade imbalances, or income distribution The observed increase in the average productivity of labor has been largely driven by the growth in TFP A large increase in the relative price of traded goods and/or a significant improvement in the terms of trade are required to reduce the U.S. trade deficit