International trade in differentiated goods, financial crisis and the gravity equation

Abstract

The study examines the effect of financial crises on international trade with a gravity equation approach. We use a large data set covering almost 70 importing and 200 exporting countries from 1950 to 2009. Thus it is possible to put the ‘Great Trade Collapse’ witnessed during the financial crisis 2008–2009 into a historical perspective. Both the period for which the crisis is observed, and the level of the trading partners’ economic development constitute important factors in explaining the negative effects of a banking crisis on international trade. As the analysis indicates financial crises have a stronger negative effect on differentiated goods compared to overall export flows. In addition the negative effects of financial crises persist even after the income effect is accounted for. The study therefore suggests that the increasing share of differentiated goods in international trade might be one possible reason for the comparatively large effect of the recent financial crisis on international trade relative to previous financial turmoil in post-war economic history.