Inventories , Lumpy Trade , and Large Devaluations

We document that economies of scale per transaction and delivery lags matter for international trade, leading importers to import infrequently and hold additional inventory. In a model with these frictions calibrated to empirical measures of inventory and trade lumpiness, these frictions have a large (20 percent) tariff equivalent, mostly due to inventory carrying costs. These frictions also alter the dynamics of imports and prices. Consistent with evidence from large devaluation episodes in six developing economies, following a terms-of-trade and interest rate shocks, the model generates a short-term implosion of imports and a gradual increase in the retail price of imports. (JEL E31, F12) The costs of international trade are large, especially in developing countries.1 Given its simplicity, iceberg depreciation has been the usual approach to modeling these costs, but understanding trade flows requires a deeper understanding of the nature of frictions involved in international trade. The particular microstructure of trade frictions has implications for ∗Alessandria: Research Department, Federal Reserve Bank of Philadelphia, Ten Indepedence Mall, Philadelphia, PA 19106 (george.alessandria@phil.frb.org); Kaboski: Department of Economics, 434 Flanner Hall, University of Notre Dame, Notre Dame, IN 46556 (jkaboski@nd.edu). Midrigan: Economics Department, New York University, 9 W. 4th Street, 6FL, New York, NY 10012 (virgiliu.midrigan@nyu.edu). We thank three anonymous referees, Rudy Bachman, Ariel Burstein, Tomas Chaney, Don Davis, Timothy Kehoe, Aubhik Khan, Sylvain Leduc, Julia Thomas and seminar participants at Cowles Foundation, UC Berkeley, Central European University, Michigan, NYU, Penn State, Texas, Wisconsin, the Board of Governors, and the Federal Reserve Banks of Chicago, Kansas City, Minneapolis, New York, Philadelphia, San Francisco and St. Louis; the 2007 ASSA and SED Meetings, and the 2008 Minnesota Macro conference. Jarcy Zee provided excellent research assistance. The views expressed here are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. 1James E. Anderson and Eric van Wincoop (2004) provide an excellent review of the evidence. whether and which trade costs are policy-mutable, how trade patterns and trade costs change over time, and what the gains to trade are (e.g., Kim Ruhl, 2005, George Alessandria and Horag Choi, 2007b, Thomas Chaney, 2008). This paper documents two important frictions faced by firms participating in international trade: delivery lags and economies of scale in the transaction technology. We study an economy in which importers economize on these costs by storing goods as inventories and use the theory to evaluate the importance of these frictions. We show that shipping lags and economies of scale play an important role in the aggregate, both for the level of trade as well as for the dynamic response to shocks to the terms of trade and interest rates. David Hummels (2001) forcefully documents nontrivial time lags between the order and delivery of goods in international trade. For instance, delivery times from Europe to the US Midwest are 2 to 3 weeks, whereas those to the Middle East are as long as 6 weeks. Manmade bureaucratic barriers slow the flow of goods across borders as well. A recent survey by the World Bank2 finds that it takes an average of 12 days (OECD) to 37 days (Europe and Central Asia) for importers to assemble import licences, customs declaration forms, and other certificates required to engage in international transactions.3 Many of these bureaucratic procedures are transaction costs that are not proportional to a shipment’s size, and thus important economies of scale characterize the technology of international trade. According to the World Bank report mentioned above, part of the cost of 2Trading Across Borders. Available at http://www.doingbusiness. org/ExploreTopics/TradingAcrossBorders/ 3In related work, delivery lags and the demand for timeliness have been shown to have important implications for gravity equation trade flows (Simeon Djankov, Caroline Freund and Cong S. Pham, 2006), location/sourcing decisions (Carolyn Evans and James Harrigan, 2005), and provide a structural interpretation of distributed lags in import demand equations (Tryphon E. Kollintzas and Steven L. Husted, 1984). Delivery lags have also been studied in business cycle models by David K. Backus, Patrick J. Kehoe and Finn E. Kydland (1994) and Elisabetta Mazzenga and Morten O. Ravn (2004).