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Tuesday, April 11, 2006

Great essay on globalisation

I loved the book From Beirut to Jerusalem by Thomas Friedman (1998) when I read it (at the time). After that, I enthusiastically bought and read his The lexus and the olive tree. I got something from that book but not a whole lot. When The world is flat came out, I read an extended essay which he put out in the The New York Times and chose to skip the book. Friedman engages in too much rhetoric and now I see the book as the latest `management guru' book. I never read management gurus.

Today, I read a marvellous essay on the book by Edward Leamer which is forthcoming in Journal of Economic Literature. Much unlike Thomas Friedman, it is actually insightful and (atleast for me) said new things about globalisation other than the obvious insights of gains from trade based on diminishing frictions. If you've been uptodate with the field of international trade, it might be familiar territory, but for the rest, it's a great read.

I was struck by the fact that over time, the distance coefficient in gravity models has not dropped. It is a really surprising result. I wonder why this happens. Certainly, looking from an Indian perspective, there has been a huge upsurge of trade to faraway locations, made possible by reduced transaction costs. In particular, in terms of BPO, India appears to do huge trade with faraway locations (e.g. UK and UK) and negligible trade with close-by places. This doesn't sound like a gravity model story to me. (Richard Portes & Helene Rey have this famous result from 1999 on gravity model type stories with capital flows also, and there also, I feel that India's a bit of an outlier, doing very little business with the immediate neighbourhood.)

One possibility that struck me was like this. In the last 30 years, there have been important political developments leading to lowered trade barriers for intra-regional trade in 3 regions: EU, North America and (to a lesser extent) East Asia. Each of these events - e.g. NAFTA - might give an upsurge of trade between countries at short distances to each other, thus swamping the effects of improvements in the transportation of goods. If this happened, then it's a one-off, and in the future, we may get a decline in the distance coefficient.


  1. Hi Sir,

    A nice article for someone like me who is not too well read on the dynamics of globalisation and its issues.

    But, I have a question sir. This paper claims that trade between two countries is kind of inversely proportional to distance. Shorter the distance greater will be the trade between the two countries. But, dont you think that there is a lot more than just distances ? I agree that shorter distances keep transporation and a host of other costs lower. But, when I look at our country, the same doesnt seem to hold true. We trade more with the US and the EU than as compared to say a China, Korea, Thailand, Taiwan. etc.

    Isn't that also true for most of the other SE Asian countries - significant portion of trade with the US and the EU but less with neighbours ?


  2. The importance of distance, as seen in the empirical evidence, is nothing less than remarkable. People use the phrase `gravity model' for a structure where the trade between two countries is like GMm/r^2 where G is some constant, M is one GDP, m is the other GDP and r is the distance between the two.

    Why does distance matter? It is partly about transactions costs and the frictions of goods arbitrage. But equally, it is about "intellectual distance". You tend to do business with someone you know, someone you are comfortable with, someone who speaks your language, and where the accounting/legal structures are convenient. These area all correlated with distance.

    I thought the most interesting point made by Ed Leamer in his article was that contrary to the popular view that "distance is dead" or that "distance viewed through bandwidth is more relevant than distance viewed through geographical distance", the fact remains that distance is alive and well.

    I have previously mentioned the remarkable distance-related facets of capital flows (Portes & Rey). With capital flows, you might have thought physical distance might not matter that much. But it does.

  3. Ajay,

    I accidently found your blog and then found the mention of Leamer's critique of "World is Flat" I have been looking for economics blogs written for India and the closest I could find was Atanu's blog. For US there are so many like Greg Mankiw's blog, New Economist, Brad Delong etc. Quite happy to have discoverd you.

    If you know of any more similar weblogs please do let me know. Or may for everyone put somelinks on your blog.

    Pankaj Narula (हिन्दी)
    pankajnarula at gmail dot com


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