Product durability and trade volatility

January 24, 2012

By Dimitra Petropoulou and Kwok Tong Soo

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 nondurable, nontraded 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 nontraded 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.> ; Thus the model 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.”

This paper provides interesting microfoundations to the collapse of world trade during the recent recession, with trade contracting much more than GDP. Building on the assumption (strongly supported by recent evidence) that durables account for a significant share of traded goods, the model develops a theoretical  link between a fall in GDP – which reduces consumers’ expected lifetime wealth, and therefore their demand for durables vs. non durables – and a fall in trade flows.


Institutional Quality and FDI: An Analytical Approach

January 20, 2012

By Rodolphe Desbordes & Julia Darby & Ian Wooton


We ask whetherMNEs’ experience of institutional quality and political risk within their “home” business environments influences their decisions to enter a given country. We set out an explicit theoretical model that allows for the possibility that firms from South source countries may, by virtue of their experience with poor institutional quality, derive a competitive advantage over firms from North countries with respect to investing in destinations in the South. We show that the experience gained by such MNEs of poorer institutional environments may result in their being more prepared to invest in other countries with correspondingly weak institutions.


In the current search for a theory on FDI by MNEs from the South, this paper offers a model that aims to explain some of the paradoxes that have emerged from the (very few) empirical studies on the foreign location choices of these firms. One of the most puzzling results is that MNEs from the South seem to be attracted to host countries with poor institutional environments, in contrast with the widespread evidence that ‘good’ institutions attract FDI.  The authors model the present value of an FDI as depending  on (1) an ‘experience effect’ that reduces the risk of FDI in relatively risky environments for countries having past experience in a similar environment at home; (2) a ‘demonstration effect’ due to previous FDI from other firms from the same home country in the same host economy (something which resembles what has been previously called a ‘national’ agglomeration effect?).