Thursday, 24 December 2009

Trade and the trade-income link

The effects of distance on trade and of trade on income have been a puzzle for economists for centuries. A new column, at, by James Feyrer entitled The 1967-75 Suez Canal closure: Lessons for trade and the trade-income link, presents new evidence on this issue from an usual natural experiment – the 1967-1975 closure of the Suez Canal.

Feyrer's results suggest that a 10% decrease in ocean distance results in a 5% increase in trade. Also, he estimates that every dollar of increased trade raises income by about 25 cents. These income increases occur relatively quickly, reaching a new level four to five years after the shock.

Moreover this particular example has the nice property that the closure of the canal caused movements in trade that are unconnected to income for most countries and thus the causality clearly runs from trade to income and not the other way around. Increases in trade volumes appear to lead to higher income.

The full paper is Feyrer, James (2009), “Distance, Trade, and Income – The 1967 to 1975 Closing of the Suez Canal as a Natural Experiment,” NBER Working Papers 15557.

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