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U.S. Economy

One Fact Constraining Globalization: It's a Big Planet

Trade is remarkably resilient among neighboring countries.

As the Trump administration continues to evolve, one lesson is that globalized economic trade relations are probably more stable than they might have appeared at first. Most of the talk of trade wars is dwindling, the proposed renegotiation of Nafta seems to be minor, and the Mexican peso and stock market have bounced back since Donald Trump’s election.

Yet none of those developments should come as major surprises. Globalization probably won’t contract much because globalization, at least in the form of international trade, didn’t proceed as far as many people had thought. In fact, the ability of trade to surmount barriers of distance probably never went up in the first place. One implication is that nearby trade, including trade with Mexico, is remarkably robust.

QuickTake Free Trade and Its Foes

To understand that claim, consider a construct from international economics known as the gravity equation. In a world littered with economic theories that fail to pass empirical tests, the gravity equation is a welcome relief because it fits the data fairly well. The equation takes varied forms, but a simple variant suggests that, once we have adjusted for the gross domestic product of countries and some other control variables, trade is on average inversely proportional to distance. More concretely, the U.S. trades much more with Canada than with Australia, even though the economic profiles of Canada and Australia are relatively similar.

It is important to consider GDP here. The U.S. doesn’t trade much with Barbados, because Barbados is a small economy, but the U.S. trades much less yet with a comparably small economy in the South Pacific.

The most surprising result from the research on trade and distance is that the ability of trade patterns to surmount barriers of distance has not in fact increased over time. You might think that with the internet, highly efficient ports and powerful multinationals, geographic distance would predict trade patterns less well over time, but that has not been the case. As one study noted, according to a meta-analysis, “trade decreases with distance by at least the same amount today than thirty years ago.”

Again, to put that into concrete form, the tendency of the U.S. to trade with Canada or Mexico, relative to trading with Australia or Turkey, is at least as pronounced as it used to be.

Just as the internet did not herald the “death of distance” but instead led to a concentration of talent in the San Francisco Bay Area, New York City, London and other megacities, so have contemporary technologies kept trade geographically clustered.

The pessimistic reading of trade clustering is that human beings simply have not spread their wings very far. But these days, I find the gravity equation to be a comfort. Given that our ability to trade across great distances has not outraced our ability to trade nearby, I am not expecting any kind of a major trade snapback or correction. The evolution of trade, rather than throwing out fragile, delicate spokes, has instead made some fairly hardy connections, sturdy enough it seems to survive Trump’s rhetoric.

It remains an open question why geographic proximity has so much predictive power for trade, but researchers are pretty sure the costs of physical transportation are too low to account for the observed barriers. More plausibly, individuals form network connections with those who live nearby, and those connections boost subsequent trade. Many top Mexican executives, for instance, went to American business schools, where they developed contacts more useful for trading in the U.S. than for trading with, say, China or Russia.

I do read some cautionary hints into the research on trade and distance. For instance, American trade with China may well be more fragile than American trade with Mexico, precisely because the network connections to China are weaker. Trump’s summit with Xi Jinping this week thus probably runs a greater trade risk than the recent rhetorical spats with Mexico, however rocky the latter may have seemed. Also, if we wish to cement our trade ties with China, we could invest more in network connections, such as making it easier for Chinese students to study in America or taking in more Chinese immigrants. More generally, if you are looking for vulnerable trade relationships in today’s world, probably you should be more worried about China and Africa than either Western Europe or North America.

When trying to understand globalization looking forward, we must resist the temptation to believe the most puffed up reports about what we achieved in the past. The bright side is this: The continuing relevance of distance may be part of what is keeping our current world stable.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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