In our new work,
we enhance the New Keynesian
Dynamic Stochastic General Equilibrium Model (DSGE) by incorporating a distance
shock parameter into the transaction costs function. We show that distance does
not impede trade, as conventionally assumed in gravity-based trade models. Rather,
we show that a country’s economic benefit from trade depends on the length of
time its main macroeconomic variables (gross domestic product, consumption,
capital accumulation, investment, real money balances, and inflation) react to
a distance shock, likely caused by today’s global economic uncertainty: i.e., what
Jeffry Sachs of Columbia University has called ‘man-made supply shocks’.
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Globalization, trade
liberalization, information technologies and low transport costs have all
shrunk distances leading us into the global ‘village’. Geographical distance has
become largely irrelevant in trade models, replaced by economic distance
as this is represented by the low transport costs of large ships. This, for
instance, allows China to import iron ore from Brazil, three times the distance
of its neighboring Australia.
Recently, this reality
has started to change, together with the emergence of the term de-globalization.
Global economic uncertainty (GEA), deriving from trade frictions, inflation, embargoes,
wars, strikes, etc. --what Jeffry Sachs of Columbia University has called man-made
supply shocks--, is shortening global supply chains, giving rise to nearshoring,
friendshoring, 3D printing, etc.. Interestingly, GEA creates regional
distribution hub-countries, if one were to just look at Chinese investments in
Mexico (for USA) and Turkey (for Europe)[1].
What we show in our
work is that GEA changes distance from a geographical constant to an
economic ‘shock’ variable, with asymmetric effects. With the use of Iran as an
example, we show that the country’s economic benefit is far greater by joining
the Shanghai Cooperation Organization (SCO), despite the much longer distances from
SCO countries, rather than the International North-South Trade Corridor (INSTC)
of Russia. Again, the distance of economic interaction plays a less
significant role in advancing economic welfare, depending on the reaction time
to distance of main macroeconomic variables such as gross domestic product,
consumption, capital accumulation, investment, real money balances, and
inflation.
HH
[1] China was given one billion euro to Turkey, to
develop a production facility for its BYD electric car, thus bypassing EU’s
recently established import duties on Chinese electric cars.
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