WORLD TRADE  
ORGANIZATION  WT/TPR/OV/12 
18 November 2009 
 
 (09-5716) 
Trade Policy Review Body  
  
 
OVERVIEW OF DEVELOPMENTS IN THE  
INTERNATIONAL TRADING ENVIRONMENT
1 
 
Annual Report by the Director-General  
 
 
PART B:  SHAPING FACTORS FOR TRADE: LOOKING TO THE FUTURE  
 
 
Table of Contents  
 
 
    P a g e  
EXECUTIVE SUMMARY .............................................................................................................. ...................3 
I. INTRODUCTION................................................................................................................ .................9 
II. GLOBALIZATION AND TRADE.................................................................................................... .10 
III. FACTORS LIKELY TO AFFECT THE FUTURE EVOLUTION OF TRADE ................................12 
 A. M ACROECONOMIC CONSEQUENCES OF THE CRISIS .................................................................12 
  1. Negative wealth eff ect on aggregate demand .........................................................12 
  2. Reduced global imbalances ....................................................................................16 
  3. Undoing the "g reat moderation"? ...........................................................................18 
 B. F INANCIAL DELEVERAGING AND REGULATORY REFORM ........................................................19 
 C. T HE ROLE OF THE DOLLAR IN INTERNATIONAL TRADE ...........................................................21 
  1. Introduction ............................................................................................................21  
  2. Factors determining the inte rnational role of a currency ........................................23 
  3. The effect of the financial crisis on the international role of the dollar ..................24 
 D. F RAGMENTATION OF PRODUCTION ........................................................................................25 
  1. The magnification effect.........................................................................................26 
  2. Change in business practices ..................................................................................26 
  3. Implications for developing countries ....................................................................30 
  4. Conclusions ............................................................................................................30 
                                                      
 1 This Report covers the period October 2008 to October 2009.  It is presented pursuant to Paragraph G 
of the Trade Policy Review Mechanism and aims to assist the TPRB to undertake its annual overview of 
developments in the international trading environment that are having an impact on the multilateral trading system.  The Report is issued under the sole responsibility of the Director-General.  It has no legal effect on the 
rights and obligations of Members, nor does it have any le gal implications with respect to the conformity of any 
measure noted in the Report with any WTO Agreement or any provisions thereof.   WT/TPR/OV/12 
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    P a g e  
 E. C HANGING PUBLIC ATTITUDES TOWARD GLOBALIZATION .....................................................31 
  1. Introduction ............................................................................................................31  
  2. Recent surveys on attit udes towards glob alization .................................................31 
  3. Determinants of  attitudes to  trade...........................................................................34 
  4. Determinants of a ttitudes to immi gration ...............................................................35 
  5. Public perceptions on globalization and the crisis ..................................................35 
  6. Conclusions ............................................................................................................36 
 F. O THER LONG -TERM CHALLENGES ..........................................................................................36 
IV. CONCLUSIONS ............................................................................................................... .................38 
 
  WT/TPR/OV/12 
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 EXECUTIVE SUMMARY 
1. The world faces its deepest economic crisis since the 1930s with merchandise trade 
contracting at a rate that expert reckoning suggest s is even greater than that experienced during a 
similar stage of the Great Depression.  The reduction in  trade flows stands in contrast to the process of 
economic integration and th e dramatic expansion of trade since th e end of the Second World War.  In 
many respects, this process of globalization was deep er and more broadly based than the first wave of 
globalization that took place between 1870 and the start of the First World War.   
2. The increased economic inter-dependence among na tions was driven by a combination of 
technological change, economic polic y reforms, and geopolitical changes.  The technological drivers 
of globalization were innovations that improved the speed of transportation and communications and 
lowered their costs.  Equally notable are cha nges in business and production methods which allowed 
the rise of global supply chains.  Globalization be nefited from economic policies that resulted in the 
reduction or elimination of restrictions on intern ational trade, financial flows and movement of 
persons.   
3. At this stage of the crisis, there is growi ng evidence that the worst is behind us. But as 
governments contemplate crisis exit strategies, one question comes to mind.   How different will the 
world look after the crisis?  More specifically, will the crisis result in a retreat from economic 
integration?  Underlying this issue is a distinction between cyclical and secular forces.  On the one hand the current contraction in economic activity and trade may be revealed to be a once-in-a-hundred 
year's downturn so that over time the world will return  to the status quo ante.    In this case the only 
real challenge is to ensure that any damage oc casioned by the crisis is undone upon exit.  But the 
other possibility is that the origins of the crisis and its severity will combin e to create a turning point 
that will put the world on a different, less integra tionist path.  The argument for this second possibility 
will be strengthened if there are other secular, centrifugal forces already at work in the world 
economy, and which perhaps the crisis will accentuate. 
Shaping factors for trade
 
 
4. While it may not be possible to provide a definitiv e answer to this question, it is possible to 
identify those factors that are likely to have a hand in shaping the answer.  Principally, they include 
the macroeconomic consequences of the crisis, th e deleveraging in the financial sector and likely 
regulatory reform; whether the U.S. dollar continues to play a dominant roles in the international 
economic system; the fragmentation of production ("offshoring" in common parlance) and public 
attitudes towards trade and globalization.   
Macroeconomics consequences of the crisis  
 5. There are three main issues related to the macr oeconomic consequences of the crisis that are 
playing a role in international trade: the contrac tion in aggregate demand as a result of the massive fall 
in asset prices, the reduction in gl obal imbalances, and whether there will be a reversal of what has 
been termed the “great moderation”.   
6. Estimates of the value of wealth lost as a c onsequence of the crisis are large, whether 
measured in absolute terms (in the tens of trillions of dollars), or relative to  household wealth (20 per 
cent in the case of the United States) or relative to  the size of the economy (in the order of between 
70 per cent to 90 per cent of GDP in some countri es).  The traditional channel through which changes 
in household wealth affect economic activity is th rough the induced change in consumption. Once an 
unexpected loss of wealth occurs, consumers woul d cut their current spending as a fraction (roughly 
equal to the real interest rate) of the change in wealth and maintain the new level of spending over a 
certain period of time.  This effect would operate no matter what form wealth is held, whether in WT/TPR/OV/12 
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 financial assets or in real assets, such as a home.   The estimate of the marginal propensity to consume 
out of wealth found in the empirical literature gene rally is between 1 per cen t and 10 per cent.  This 
means that a $10 trillion reduction in wealth could permanently reduce consumption by as much as 
US$1 trillion a year.   
7. This reduction in consumption in  developed countries severely affected by the crisis will 
show up as a reduction in current account defi cits.  This follows from the condition for 
macroeconomic balance where the difference between domestic i nvestment and domestic savings 
must be financed by foreign savings.  Holding inve stment constant, an increase in domestic savings 
requires less foreign savings.  Given the prominen t role played by these imbalances in increasing 
trade in the past decade, such a reduction may well imply a slower rate of growth in international 
trade.  This prospect raises two important questi ons for trade as well as for the development strategy 
pursued by a number of emerging economies.  Fi rst, will a rebalancing reduce opportunities for 
economies to rely on export-led growth as a deve lopment strategy?  Second, how far can increased 
domestic demand in some large emerging economies such  as China, India, and Brazil, which have not 
suffered as huge a reduction in grow th as developed economies, fill th e gap left by the industrial 
economies?   
8. Many emerging Asian countries have followed e xport-led strategies that have in large 
measure been remarkably successful  in spurring economic developmen t. One way that this strategy 
can be characterized is that it involved the cross- border transfer of goods and services to developed 
markets in exchange for financing the centre c ountry's current account deficits.  But given the 
likelihood of prolonged weakness in  demand for emerging Asia's exports , the source of future growth 
for emerging economies may need to come from domestically generated demand.  Thus, this 
rebalancing of demand may be in emerging Asia's own self-interest.  This transformation could be 
managed in a number of ways: developing or improvi ng social safety nets to reduce precautionary 
savings by households; accelerating the development of the domestic financial system to increase its 
efficiency in allocating savings to domestic inv estment; adopting a more flexible exchange rate 
regime; and obtaining a greater voice in interna tional financial affairs so as to help reduce the 
incentive to self-insure against future financial crisis by accumulating large foreign exchange 
reserves. 
9. Whether the projected decline in current account  imbalances actually leads to weaker trade 
growth depends in part on whet her domestic demand in large emerging economies such as China, 
India, and Brazil can fill the gap left by the industrial economies. In purchasing power parity terms, 
Brazil, Russia, India, and China combined are about equal to the size of the U.S. economy.  However, 
some estimates suggest that this will not be suffi cient to offset the reduction in global demand 
stemming from lower U.S. and EU growth in the next few years.   
10. Since the early 1980s, there has been reduced volatility in infl ation and GDP growth rates of 
industrial countries. This pattern has been so striki ng that a term has been coined for it: the great 
moderation.  Stability in the global macroeconom ic environment can enable more cross-border 
transactions to take place.  Firms face reduced cost s of operating in different countries. Firms engaged 
in international trade will encounter less volatility in exchange rates and can operate at a greater scale.  
Investors will be subject to less risk when making cross-border investments.    
11. At least three reasons have been found to explai n this great moderation.  The first is luck: the 
world has simply been fortunate during this period not to have experienced a large adverse shock.  
The second explanation is structural change in economic institutions, tec hnology, business practices, 
or other structural features of the economy that ha ve improved its ability to adjust.  Finally, the third 
explanation attributes the phenomenon to skilled economic policymakers who developed a better 
understanding of the economy and better economic tools to manage it.         WT/TPR/OV/12 
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 12. But the aggressive fiscal and monetary response by  governments to the crisis has dramatically 
increased budget deficits and expanded money supplies.   A long-term threat of inflation will hang 
over the world if governments are unable to fashi on an exit strategy from these policies when the 
global economy recovers.  As govern ments wrestle with the many problems unleashed by this crisis - 
weak household demand, growing publ ic debts, and the rebalancing of  global demand - the world may 
be embarking on a more uncertain future in te rms of macroeconomic policymaking.  One of the 
consequences of the crisis may be a return to greater volatility in economic outcomes.  Undoing the 
great moderation may well lead to a less globalized world.        
Finance deleveraging and regulatory reform  
 
13. The crisis has resulted in a massive process of  financial deleveraging roughly measured as the 
decline in the credit to GDP ratio.  This is explaine d partly by the fall in the market value of the assets 
held by financial institutions and partly by wor sening macroeconomic conditi ons.   This has direct 
effects on world trade through a reduction in the suppl y of lending for trade, and indirect effects, 
through the reduction in aggregate demand linked to the severe credit crunch.   It is likely that this 
deleveraging process in the internati onal banking sector is far from over. 
14. One worrying consequence of the global credit cr unch is the collapse in private capital flows 
to developing countries, be it foreign direct investme nt or other forms of inflows. This is affecting 
capital accumulation, and hence growth, in countries that need capital the most.  It is limiting 
investments in trade-related infrastructure that woul d expand their capacity to trade in the future.  
Ironically, it was the growing integration of many developing country economies into the global 
economy that made them much more dependent on private capital flows.  In many instances, the 
confounding of country risk and individual bank risk has fuelled unfounded fears of default from 
perfectly credit-worthy banks in developing countries.  There may be a role for international financial 
institutions to play to correct this "perception gap" which might unfairly marginalize countries and 
institutions that have gained access to international financial markets in the early part of the decade 
and might lose it as a result of the "de-leveragi ng" process in which they bear little responsibility. 
15. Given that the financial sector was the epicentr e of the crisis, regulatory reform has been a 
major policy priority of many countries. In the shor t-term, it is possible that increased regulations may 
aggravate the credit crunch. But increased regul atory supervision can be positive for global 
integration and trade in the long run if it reduces sy stemic risk, pro-cyclical leverage and improve 
public confidence in the global financial system.  To ensure that this objective is met, regulators need 
to take certain principles into account. Regulations should be applied in a non-discriminatory manner.  
Likewise, countries having provided support to banks , either through capital injections, liquidity 
provision, government loans and guarantees should, when the deleveraging process is at an end, 
withdraw support in a way that does not leave an uneven level-playing field between national and foreign-owned institutions.   
The role of the dollar as an international currency
 
 16. Since at least the 1920s, and definitely since after the Second World War (WWII), the United 
States dollar has been the main cu rrency used in international tran sactions.  Currently, 64 per cent of 
the world's allocated foreign exchange reserves are he ld in U.S. dollars.  The share would probably be 
larger if unallocated foreign exchange reserves ar e taken into account. More than 88 per cent of daily 
foreign exchange trades involve the dollar.  The pr ices of many primary commodities, including oil, 
are invoiced in U.S. dollars. 
17. The existence of a vehicle currency saves on transaction costs and makes possible more 
international exchange than otherwise.  It is cheap er for payments between agents in foreign countries 
to be made indirectly using the international curre ncy than directly by trading in their own currency WT/TPR/OV/12 
Page B-6  
 
 markets.   The economic literature suggests that there at least four important characteristics of a 
country that determines whether its currency can serve as a vehicle currency.  The first is its size, in 
terms of output, trade and financial flows.  The sec ond is the depth of its financial market.  The third 
is confidence by the rest of the world in the economic policies that the country pursues, and in 
particular, that it will not abuse its privilege of sei gniorage.  Lastly, there may be network externalities 
involved so that the more widely a currency is used in international ex change, the more economic 
agents will want to use it in economic transactions.     
18. Some of the determinants that favour the domin ant role of the dollar may be eroded by the 
crisis.   Over the next five years,  the U.S. economy is expected to gr ow more slowly than the rest of 
the world.  The divergence in expected growth is particularly stark when the United States is 
compared with developing countries like China and In dia.  While the United States will continue to be 
the biggest economy in the world, its relative share of global output will see a decline.  Large future 
U.S. fiscal deficits and the incipient threat of inflation from moneta ry expansion may erode 
confidence in the future value of the dollar.  Th ere are also more long-term trends, such as the 
persistent U.S. current account deficits and the de preciation of the dollar that may work against the 
currency.  However, the presence of network externa lities creates inertia in the use of an international 
currency so that it retains its dominant position even if the other determinants argue for the currency's 
diminished importance.  This means that although there may be secular and crisis-related forces that 
are working against the international role of the U. S. dollar, it need not immediately lose its role as a 
vehicle currency.   
Business fragmentation
 
 
19. The international fragmentation of production has pl ayed an important role in the evolution of 
international trade in the last half century.  Go ods are increasingly made in two or more sequential 
stages and firms increasingly rely on imported goods. More recent developments have seen firms not only source inputs from foreign countries, but also offs hore office tasks.  This process has been driven 
by technological improvements and regulatory change s which collectively have reduced transport and 
communication costs as well as the cost of tariff protection.   
20. Firms benefit because they can reduce their costs by locating some of those production 
activities in countries which have a comparative a dvantage in those stages of production.  Many 
developing countries have become hosts to these o ffshored activities and benefited from increases in 
foreign direct investment (FDI), employment and trade.  But many other developing countries have 
been left out from these production networks.  The economic literature has identified what may be 
lacking in those countries, and consequently, what they would need to invest in if they wish to be part 
of international production networks in the future : a sound institutional framework that can enforce 
legal contracts, good physical infrastructure, and lower costs of doing business.   
21. Offshoring may have served as an important cha nnel through which the financial crisis has 
been propagated to international trade. In a wo rld with offshoring, the volume of trade changes 
proportionately more than the change in GDP b ecause parts and components have to cross national 
borders several times.  Trade also declines in a more synchronised way because the reduction in 
imports following a negative demand s hock is reflected immediately in the reduction of exports by the 
same country.   
22. Offshoring is probably here to stay since the technological advancements  that have made it 
possible are unlikely to be reversed.  However, it is also fair to point to some long-term and crisis-
related factors that may work in the opposite dir ection.  Higher energy prices can undermine the 
incentive to offshore given the importance of the oil pri ce in transport costs.  If the long-term trend is 
towards higher energy prices, offshoring may be one  of its casualties.  Increased sensitivity of 
consumers to climate change may reduce the demand for products that need to be transported many  WT/TPR/OV/12 
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 times or travel long distances.  Since these characteris tics are typical of offshored goods, this shift in 
consumer preferences may reduce offshoring.     
23. The government response to the crisis is likely to  be a major factor to consider as well.  If 
governments respond to the crisis by turning protecti onist, the higher trade costs will make offshoring 
less profitable.  The reliance on subsidies by many  rich countries may also induce some stages of 
production in vertically specialized production netw orks to switch back to developed countries.  
Anticipating that rich countries will be more likely than poor countries to subsidize their private sector 
during a crisis, firms that have offshored operati ons in developing countries may choose to relocate 
back some of their production to rich countries.  
Public attitudes  
 
24. Continued public support for trade and globa lization is necessary if governments are to 
remain committed to economic openness.  Although the crisis may be expected to sour public 
perceptions of the benefits from trade, strengtheni ng or expanding social protection systems may help 
mitigate the fallout.     
25. A number of institutions, such as Pew, the Financial Times/Harris Poll, and the German 
Marshall Fund, periodically conduct surveys of public  opinion on trade and globalization.  They show 
that while attitudes to trade continue to be positi ve, these have gradually worsened in the past few 
years, especially in more advanced economies.  A ttitudes towards immigration appear to be more 
stable over time.  However, people tend to be  more anti-immigration than anti-trade.   
26. Globalization influences public perceptions thro ugh its effects on the distribution of income 
and on economic uncertainty.  Changes in both of these variables may be resp onsible for the gradual 
rise in anti-trade attitudes particularly in c ountries where welfare programmes are weak or non-
existent.  Thus, sustaining positive attitudes to op en trade requires social safety nets and welfare 
programmes that lower the negative consequences of economic uncertainty.  However, a welfare 
system raises the fiscal costs of low-skilled immi gration and worsens anti-immigration sentiments of 
natives in receiving economies.  This may suggest a kind of trade-off for policymakers who wish to 
increase public support for globaliza tion through the expansion of social protection systems. They 
may succeed in strengthening support for trade openn ess but at the cost of reducing support for 
openness to low-skilled immigrants. 
27. It may be too early to infer the effect that the economic crisis has ha d on public attitudes and 
we lack world-wide surveys.  Nevertheless, the cr isis has introduced greater economic uncertainty and 
is likely to worsen attitudes towards globalization.  In countries where welfare systems are more 
developed, attitudes to immigrants may worsen. In countries where welfare systems are less developed, the changing mood may take  the form of a rise in anti-trade sentiments.  The danger is that 
the hostile mood will eventually lead to trade restri ctions and that once these barriers are in place they 
will be difficult to reverse.  Several governments  have responded to the economic crisis by boosting 
public spending and revitalizing welfare programmes.   To the extent that these programmes reduce 
economic risk and uncertainty, they may have a posit ive effect on voters' support for open markets.   
Other challenges
 
 28. There are also other long-term challenges such  as climate change, scarcities in food, energy 
and natural resources, and new private standards that  are likely to confront the global economy in the 
future.       
29. Private standards can perform economically useful functions.  They can be a way for firms to 
appeal to changing consumer preferences and a form of quality control over complex production WT/TPR/OV/12 
Page B-8  
 
 processes.  However, the proliferation of private standards and, in the end, of many competing 
standards for the very same products, could redu ce economic efficiency.  This could end up 
hampering the attainment of the environmental, saf ety, and other regulatory goals that these standards 
may be designed to achieve.  In  addition, private standards may occasionally arise from a desire to 
restrict competition and trade.  While WTO ru les have focused on government mandated product 
standards (technical regulations), many future standa rds are likely to be generated by private firms 
and industries.  The concern is that in the future an  increasingly larger part of international trade will 
be covered by standards that are not subject to multilateral disciplines.  
30. Since 2003, the prices of food, energy and natura l resources have been rising.  The advent of 
the financial and economic crisis put a halt to this trend.  This rise is explained by variety of different 
factors, such as the rapid economic growth and ri sing demand for food in some emerging economies, 
droughts, and the increased production of biofuels  from foods. High energy prices have made 
agricultural production more expensive by raising the cost of inputs like fertilizers, pesticides, and 
transportation services.  Governments have res ponded to high energy prices by encouraging the 
production and use of bio-fuels which led to a shift in cultivation away from food and towards  
bio-fuel feedstock putting further pressure on food prices.  Rising primary commodity prices have 
benefited commodity exporting developing coun tries but harmed a number of food-importing 
developing countries.  One concern has been with the use of export restrictions by countries trying to alleviate food scarcity at home.  This can occasionally exacerbate scarcities in world markets. 
31. In addition to the many threats to humankind posed by rising global temperatures, climate 
change can affect the pattern and volume of interna tional trade flows. Climate change can increase the 
vulnerability of the supply, transport and distri bution chains upon which trade depends thereby 
increasing the cost of international trade.  Risi ng average temperatures and increasing frequency of 
extreme weather events can lead to shifts in the geographical pattern of production and hence in the 
direction and volume of international trade flows. This effect will be stronger in those countries 
whose comparative advantage stems from climatic or geographical factors.  Countries that are 
unprepared for these changes, which most likely will be the poorest countries, may face enormous 
trade adjustments. 
32. The link between climate change and trade is not unidirectional.  International trade can play 
a role in mitigating climate change and in helpi ng countries adapt to its consequences.  Trade serves 
as a channel for spreading goods, services and technologies that are more energy efficient or emit less greenhouse gases.  This is the contribution that th e liberalization of environmental goods and services 
in the Doha Round can make to the effort to mitiga te climate change.  In addition, trade can help 
bridge differences in demand and supply conditions that may arise as a result of changes to the 
geographical patterns of production from climate change.      
33. One key worry would be a failure by countries to  achieve international agreement on how to 
tackle climate change.  It can lead countries to use trade measures unilaterally to counterbalance the 
effect of climate change mitigation measures on th eir industries' competitiveness or as a way to 
strategically influence the environmental policy pursued  by their trade partners.  In effect, the absence 
of an international environmental solution may spill over into the trade arena, stoking trade tensions 
and reducing the potential growth of international trade.  
Conclusions
 
 
34. The massive retrenchment in international tr ade flows reflects the economic shock from the 
worst downturn since the 1930s.  What is less certai n is whether the economic shock has also set in 
motion forces that in the future will work against greater economic integration. In any case, there are 
certain steps governments could take now that c ould help revive international trade flows and 
strengthen the international trading system.    WT/TPR/OV/12 
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 35. Macroeconomic policies would need to be s upportive given the current weakness in private 
demand.   They also need to dovetail with the effort  to revive international trade.  This means that 
existing and future policies must be designed so th at they are non-discriminatory and do not favour 
home suppliers relative to foreign suppliers. As  global imbalances are unwound, export-oriented 
emerging economies will need to depend more on dom estic sources of growth.  Although it is easier 
said than done, policymakers must be ready to withdr aw stimulus and liquidity in an orderly fashion 
once the recovery gains solid footing.    
36. Regulatory changes in the financial sector shoul d be applied in a non-discriminatory manner. 
Countries that have provided support to their financial sector during the crisis must ensure that as part 
of their exit strategy it does not leave an uneven level-playing field betw een national and foreign-
owned institutions.     
37. Given the expected huge shortfalls in private capital flows to developing countries, 
multilateral, regional and bilateral donors must step up their efforts to deliver and expand aid for 
trade.  By providing resources to build the trade-re lated skills and infrastructure that are vital to the 
integration of the poorest countries into the internati onal trading system, aid for trade will help these 
countries recover from an economic crisis that they had no hand in creating.  
38. With unemployment likely to continue to ri se until at least next year, increasing social 
spending would help avert a looming social crisis. In  developed countries that have been hard hit by 
the financial crisis, social protection systems are a valuable mechanism for underpinning public 
support for open trade.  It is also valuable in a nother context as a mechanism to assist rebalancing of 
global demand since the lack of social protection systems in emerging economies has been raised as 
one of the reasons for which households  there have high precautionary savings.  
39. While one cannot rule out worsening employ ment conditions triggering more demand for 
trade restrictions, on the whole, the system of WTO rules have held up well in the midst of the crisis.  There has been no systemic breakdown in the inte rnational trading system and WTO Members have 
resisted the allure of protectionism.  As the wors t effects of the crisis recede, WTO Members must 
begin to remove whatever trade-restrictive meas ures they have been taken, in response to the 
economic downturn, including subsidies and other forms of state assistance. 
40. Whether it is in the context of exiting the crisis, or facing up to future scarcity in food, energy 
and natural resources, or dealing with climate ch ange, open markets provide the best way for the 
international trading system to contribute to a solution.  Beyond quickly dismantling protectionist measures, WTO Members need to push for greater market opening.  The Seventh WTO Ministerial 
Meeting provides an opportunity for members to ac celerate the final phase of negotiations so as to 
successfully conclude the Doha Round by 2010.   
I. INTRODUCTION 
41. The period after the Second World War (WWII) was one of growing gl obal integration and 
unprecedented expansion in international trade.  It  was made possible by technological innovations 
and changes to economic policies that reduced barri ers to the cross-border movement of goods, capital 
and labour.  By anchoring their deve lopment strategy to this long-term increase in intern ational trade, 
many developing countries were able to structura lly transform their economies and enjoy a sustained 
period of high growth.   
42. The economic crisis that struck the world saw a near collapse of the financial system in 
developed economies and a massive retreat in internat ional trade flows.  Only unprecedented action to 
save the financial system, large doses of fiscal st imulus and quantitative easing prevented the resulting 
economic contraction from turning into something wo rse.  As the world emerges from the depths of WT/TPR/OV/12 
Page B-10  
 
 the crisis, will we see a quick return to the econom ic trajectory that it was following before?  Or has 
the crisis caused such a rupture and created enough public distrust of those forces and policies 
favouring globalization that the world will move to an altogether different trajectory?   
43. While it may not be possible to provide a defin itive answer to these questions, the report will 
identify those factors that are likely to have a ha nd in shaping the answer .  Some of these factors 
affecting the evolution of international trade predate the current crisis while others have arisen as a 
result of the economic crisis.  The report will consid er what can be done to revive international trade 
flows and strengthen the international trading system .  The report will pay particular attention to the 
plight of developing countries, examining how they have been affected by the crisis and how they, 
with the assistance of the international community, can best respond to the emerging challenges.   
44. The report is organized as follows.  Section II describes the course of economic integration in 
the post WWII period and identifies the main drivers of globalization.  Section III identifies those factors that are likely to have both an immediat e and long-term influence on the development of 
international trade. They include the macroeconomic consequences of the crisis and, in particular, the 
likelihood of prolonged weakness in aggregate dema nd; financial deleveragi ng and regulatory reform 
in the financial sector; the existence of a vehicl e currency in the international economic system; 
fragmentation of production (e.g. offshoring); and pub lic attitudes to globalization.  The analysis 
extends to other long-term issues such as the growth  in private standards, greater scarcity in food, 
energy and natural resources, and climate change.  Section IV concludes with a number of proposals 
about how governments can best revive internati onal trade and strengthen it against those centrifugal 
forces that have been unleashed by the crisis.   
II. GLOBALIZATION AND TRADE 
45. Since the mid-19
th century, there have been at l east two episodes of increased global 
integration.2  The first began in 1870 and ended with th e beginning of the First World War.  The 
second episode began in the aftermath of WWII and c ontinues today.  These two most recent episodes 
of globalization have been characterized by in creased integration in trade, capital flows and 
movement of labour, although there ar e differences in the importance each  of these elements played in 
the two episodes.  In both periods, rapid trade and ou tput growth went together with major shifts in 
the relative size of the economies involved.   
46. After WWII, international trade entered a long period of record expans ion boosting real world 
merchandise exports by 6.2 per cent ov er the 1950-2007 period.  This gr owth was faster than that seen 
in the first wave of globalization and was accompan ied by a long-term shift in the composition of 
world merchandise trade, with a substantial rise in the share of manufactured goods and a marked 
decline in agricultural products and non-fuels minera ls.  The share of agricultural products (including 
processed food) in world merchandise trade declined  from more than 40 per cent in 1950 to less than 
10 per cent since 1999. The share of fuels in world merchandise exports has fluctuated widely due to 
the volatility in their prices. The highest shares for fuels in world merchandise exports were reached 
in 1974, 1981 and 2007 (a 20 per cent share on each occasion). 
47. This second period of globalization was also marked by the increased participation of 
emerging economies in the international economy, fi rst as exporters of raw materials and natural 
resources, but increasingly too as exporters of labour-intensive manufactures and information technology products and services.  An important ro le in this latter process was played by emerging 
                                                     
 
2 Baldwin, Richard, and P. Martin.  1999. 'Two Waves of Globalization: Superficial Similarities, 
Fundamental Differences" in Globalization and Labour, ed. H. Siebert, 3-59. Tubingen, J.C.B. Mohr for Kiel 
Institute of World Economics.  WT/TPR/OV/12 
 Page B-11 
 
 
 economies in Asia, beginning with the newly industrializing economies3 (NIEs) who, from the 1960s 
onwards, followed an outward oriented trade po licy and succeeded in dramatically increasing their 
merchandise exports.  They were eventually follow ed by the world's two most populous states as 
China and India allowed private enterprise to fl ourish and opened up their markets to trade and 
investment. These economic changes have been rewa rded by a sustained period of rapid economic 
growth lifting hundreds of millions from poverty.  However, many least-developed countries, who 
collectively account for less than 1 per cent of world trade, have not been able to fully benefit from 
the process of globalization.   
48. Globalization was driven primarily by technol ogical innovations, adoption of more liberal 
economic policies and geopolitical changes.  Ch ief among the technological handmaidens of 
globalization were inventions that improved the speed of transportation and communications and 
lowered their costs.  These included the development of the jet engine and its universal use in aviation 
for transporting people and goods a nd the use of containers in international shipping.  Massive 
investments in road infrastructure also allowed large shares of trade to be carried by road in Western 
Europe and North America. The other dramatic change was the revolution in information and 
communication technology. New products such as th e personal computer, the cellular phone, and the 
internet have radically lowered communication co sts facilitating the rise of global supply chains and 
contributing to other profound socio- political and economic changes.  
49. The economic policies that have contributed most  directly to global integration have been 
those which reduced or eliminated restrictions on international trade a nd financial transactions. 
Currencies became convertible and balance of paymen ts restrictions were relaxed.  Tariff reductions 
were pursued multilaterally thr ough successive GATT negotiations and bilaterally and regionally 
through preferential trade opening as well.  But ma ny countries undertook trade reforms unilaterally.  
Many developing countries that initially had inward -looking trade policies began to shift away from 
the strategy of development through import substituti on.   One also needs to mention other economic 
changes that have contributed, perhaps in a more indirect way, to globalization. Beginning in the 
1970s, many governments reformed their policies on major service industries such as transport and 
telecommunications.  This process involved privati zation of state-owned enterprises and the removal 
of government restrictions so as to increase competition in these sectors.  Finally, global 
macroeconomic stability marked by the reduction in output and infla tion volatility in major economies 
has provided a conducive environment to internati onal integration (see the discussion of the "great 
moderation" in section III.A.3).     
50. Geopolitical changes also facilitated globalization. The dissolution of the Soviet Union and 
the failure of the model of central planning led to  the adoption of market oriented economic policies 
in what was once the socialist bloc and to their eventual integration into the global economy.   
51. Global integration in product, capital and labour markets results in a more efficient allocation 
of resources so that output and incomes are higher than otherwise. Consumers and producers have a 
wider choice of products and services at lower prices.  Capital can flow to countries which need it the 
most for economic development. To the extent th at technology is embodied in capital goods or is 
closely linked to FDI flows, integration improve s the growth prospects of developing countries. 
Allowing workers to move across national borders ca n alleviate skill shortages in receiving countries 
or improve dependency ratios in rapidly ageing societies while alleviating unemployment or under-
employment in supplying countries.  
                                                      
3 The NIEs include Chinese Taipe i; Hong Kong, China; Korea, Repu blic of; Malaysia and Thailand. WT/TPR/OV/12 
Page B-12  
 
 III. FACTORS LIKELY TO AFFECT THE FUTURE EVOLUTION OF TRADE 
52. The dramatic retrenchment in trade and inte rnational economic integration that has been 
provoked by the current crisis raises the question of whether this simply reflects a short-term, or cyclical phenomenon, or whether the crisis has set in motion economic, social and political forces that 
will put the global economy on a less integrationist path.  As stated in the Introduction, it may not be 
possible to provide a definitive answ er to this question.  However,  it is possible to identify those 
factors that are likely to have a hand in shapin g the answer.  They include the macroeconomic 
consequences of the crisis and the unwinding of gl obal imbalances, the dele veraging in the financial 
sector and likely regulatory reform, whether the U.S. dollar continues to play a dominant roles in the 
international economic system, the fragmentation of  production (i.e., offshorin g) and public attitudes 
towards trade and globalization.  Though not covere d in as much detail, there is also a discussion of 
the likely effects of private standards, greater scar city in food, energy and natural resources, and 
climate change.  In analysing each of these issues, th e report attempts to distinguish those aspects that 
may have been present even prior to the crisis, ch anges stemming directly from the crisis and those 
effects arising from policy responses taken by governments.  
A. M
ACROECONOMIC CONSEQUENCES OF THE CRISIS  
53. There are three main issues related to the macr oeconomic consequences of the crisis that will 
be covered, all of which are likely to influence inte rnational trade in the short, medium and long-term.  
They include the contraction in aggregate demand as a result of the massive fall in wealth, the 
reduction in global imbalances, and whether there will be  a reversal of what has been called the “great 
moderation”. 
1. Negative wealth effect on aggregate demand  
54. From a macroeconomic point of view, the crisis  has been a balance sh eet crisis drastically 
reducing the wealth of households and the assets of financial institutions.  The bursting of the housing 
and financial bubbles has dramatically reduced house hold wealth, held in financial assets and homes 
prices in developed countries.   
55. Between the end of 2007 and the second quarter  of this year, the net wealth of U.S. 
households fell by US$12.8 trillion (nearly 20 per cent of their net wealth and 88 per cent of U.S. GDP).
4  For the United Kingdom, the IMF's April World Economic Outlook estimated that household 
wealth fell by about UK£1 trillion in 2008 (which is a little over 69 per cent of UK GDP).  It is 
possible to get a broader sense of this reduction in household wealth from examining trends in equity 
markets (see Figure 1 and Figure 2).  From their peak s in the third quarter of 2007 to their troughs in 
the first quarter of 2009, developed country equity  markets fell by between 56 to 60 percent in local 
currency terms.  They have recovered since althoug h they are still between a third and a half below 
their peak values (based on end-October 2009 values). If anything, stock markets in emerging markets 
fell even more dramatically, though stock ownership is less broadly based in emerging markets and, 
therefore, the knock-on effect on household consum ption will not be as strong.  International indices 
of home prices are more difficult to come by.  But the Case-Schiller composite index for home prices 
in the top ten metropolitan areas of the United States has fallen by a third since its peak in April 2006.   
                                                      
4 From Table B.100 of Flow of Funds Accounts of the United States: Second Quarter 2009, page 104.  
There has been some recovery in the third quarter of 2009 as equity markets came back from their lows in 
March 2009.  WT/TPR/OV/12 
 Page B-13 
 
 
 Figure 1 
Developed Country Stock Market Indices 
405060708090100110120
01/08/2007 01/11/2007
01/02/2008
01/05/2008
01/08/2008
01/11/2008
01/02/2009
01/05/2009
01/08/2009Index (1 Aug 2007=100)
MSC I Europe MSC I Japan MSC I North Ame rica 
Source : MSCI Barra.  
56. The deterioration in household wealth prompt s certain questions: how  do household balance 
sheets affect economic activity? Mo re specifically, how would house holds' consumption behaviour be 
altered by this massive reduction in wealth? The traditional channel through which household balance 
sheets affect economic activity is through the wealth  effect: once an unexpected loss of wealth occurs, 
consumers would cut their current spending as a frac tion of the change in wealth and maintain the 
new level of spending over a certain period of time.  Since the seminal work by Modigliani5, 
macroeconomists have generally accepted the idea that  consumption responds to changes in wealth. A 
simple formulation of Modigliani's life cycle hypot hesis is that consumers will distribute increases in 
anticipated wealth over time and th at the marginal propensity to consume (MPC) out of all wealth, 
whether from stocks, real estate, or any other s ource, should be the same small number, something 
just over the real interest rate.  Apart from the wealth effect from house prices, some have pointed to 
equity extraction as another important channe l for house prices to affect consumption.6  This involves 
borrowing by existing homeowners against the increase in  home equity.  It allows previously credit-
constrained homeowners to move toward th eir desired level of consumption.   
 
                                                      
5 Modigliani, F., and Ando A. 1963. "The Life Cycle Hypothesis of Saving: Aggregated Implications 
and Tests." American Economic Review, 53: 55-84. 
6 The effects from equity extraction can be larg e. Mian and Sufi (2009)  estimates that U.S. 
homeowners are able to extract US$0.25 to US$0.30 in cash from their houses for every $1 of growth in house 
price. Their analysis sugges ts that the home-equity w ithdrawals are primarily used  for consumption or home 
improvement, which temporarily boosts economic growth .  (See Mian, Atif, and Am ir Sufi.  2009. "House 
Prices, Home Equity-Based Borrowing, and the U.S. Household Leverage Crisis."  
http://ssrn.com/abstract=1397607.   WT/TPR/OV/12 
Page B-14  
 
 Figure 2 
Emerging market stock market indices 
20406080100120140
01/08/2007
01/11/2007
01/02/2008 01/05/2008
01/08/2008 01/11/2008
01/02/2009
01/05/2009
01/08/2009Index (1 Aug 2007=100)
BRIC Em e r g i n g  A s i a Em e r g i n g  Eu r o pe E merging L atin America 
Source :  MSCI Barra. 
57. The broad theoretical notion in Modigliani's work had led to a significant amount of research 
trying to identify the empirical relationship betw een changes in consumption and wealth.  The 
empirical literature on the wealth effect analyse whethe r, and if so, to what extent changes in wealth 
affect consumption behaviour. Giving a precise answer to this question involves statistically 
estimating the value of the MPC.  In regression models relating changes in the logarithm of consumption to changes in the logarithm of stock ma rket or housing wealth, the estimated coefficient 
measures the  "wealth effect" – the casual effect of exogenous changes in wealth upon consumption 
behaviour. 
58. The studies vary according to the type of asset (financial, housing) being considered, the 
nature of the data (macro, micro), the country (the United States, the United Kingdom, Italy, Japan, 
Australia) that is the subject of analysis and so on.   However, there are certain conclusions that these 
studies share in common. First, the wealth effects on consumption are positive and significant. In 
general, the estimated MPC is between 1 per cent and 10 per cent l (see Table 1 for the estimated 
MPCs).  This means that a US$10 trillion reduction in wealth could permanently reduce consumption 
by as much as US$1 trillion a year.  Secondly, the long-term MPC out of wealth is much higher than the short-term MPC.  This is probably caused by the fact that individuals need time to adjust their 
consumption habits when their wealth changes. Thir d, while there continues to be some uncertainty 
about whether the wealth effect from housing is equa l to that from financial assets, the effect for both 
are significant. Estimates of housing wealth effect s tend to be larger in the United States and the 
United Kingdom than in the euro area and Japan. Housing effects also vary between homeowners, 
who experience an increase in housing wealth, and renters whose consumption effects are zero or 
negative.    WT/TPR/OV/12 
 Page B-15 
 
 
 Table 1 
Estimates of the Marginal Propensity to Consume (MPC) out of Wealth 
 Country MPC  out of Financial 
Assets MPC out of House Assets Total 
Bhatia (1987) United States  0.03-0.05  
Bover (2005) Spain  0.015  
Case et al (2005) United State 0.03-0.06   
Case et al (2005) Devel oped countries 0.11-0.14   
Short run Long run Carroll et al.(2006) United States  
0.02 0.04-0.19  
Disney et al. (2002) United Kingdom  0.09-0.14  
Dvornak, Kohler 
(2003) Australia 0.06-0.09 0.03  
Mean 
household Median 
household Engelhardt (1996) United States  
0.14 0.03  
Grant and Peltonen 
(2005) Italy 0.005   
Individual 
homes Condominium Hori and Shimizutani 
(2003) Japan 0.05-0.10 
0.01 0.005  
Ludvingson,  Steindel 
(1999) United States 0.04   
Maki and 
Palumbo(2001) United States 0.03-0.05   
Paiella (2007) Italy 0.09  0.04 
Skinner (1989) United States  ≥ 0.06  
Starr-Mccluer (2002) United States 0.033   
 
59. The literature based on financial wealth ignor es the consumption beha viour of individuals 
who do not own stocks. However, given the importance of wealthy individuals in most societies, the 
consumption effects estimated from changes in financial wealth remains a good barometer for 
consumption changes at the national level.  But perh aps the biggest gap in the empirical literature is 
that it is sadly lacking in coverage of wealth effects in developing countries.   
60. This wealth effect may explain why badly hit economies such as Iceland, Ireland, Spain, and 
the United Kingdom have seen a precipitous declin e in consumer demand (see Table 2).  This 
negative wealth effect on consumption suggests th at recovery of consumer demand may well be a 
protracted process posing worrying implications for a quick turnaround or recovery in international 
trade flows since consumption expenditures represent the biggest share of aggregate demand in many 
industrial countries.  In 2008, it accounted for 70 per cent of GDP in the United States, 64 per cent in 
the United Kingdom, 58 per cent in Japan, and 56 per cent in Germany.7    
                                                      
7 U.S. data comes from the Bureau of Economic Analysis of the Department of Commerce; UK data is 
from UK National Statistics; Japanese data is from the Statistics Bureau of the Ministry of Internal Affairs and 
Communications; and German data comes from the Statistisches Bundesamt Deutschland. WT/TPR/OV/12 
Page B-16  
 
 Table 2 
Projected Change in Consumption Expenditures in Selected OECD Countries 
Countries Average: 
2000-2006 2007 2008 2009* 
Iceland 4.2 5.6   -7.7   -16.2   
Ireland 5.6 6.0   -0.8   -7.2   
Germany 0.7 -0.3   -0.1   0.4   
Japan 1.2 0.7 0.6 -1.7 
Spain 3.8 3.5   0.1   -4.4   
United Kingdom 3.0 3.1   1.4   -3.4   
United States 3.2 2.8   0.2   -1.0   
OECD Average 2.7 2.5   0.7   -1.5   
*Projection. 
Source : OECD Economic Outlook No. 85. 
2. Reduced global imbalances 
61. Reduced consumption and increased savings in developed countries severely affected by the 
crisis has some adverse consequences for trade.  It may well imply a slower rate of growth in 
international trade flows given the large role played  by consumption in some developed countries in 
increasing imports in the past decade.  One way to see the link between reduced consumption (or 
increased domestic savings) and reduced imports  is through the condition for macroeconomic 
balance: domestic investment must equal the sum of private ( SP), government ( SG) and foreign savings 
(SF):I=S p+SG+SF. 
62. But foreign savings is equal to a country's cu rrent account deficit (which also includes the 
merchandise trade balance).  The savings by foreig ners being "lent" to domestic residents must be 
matched by a corresponding excess of payments on foreign goods and servi ces.  One side effect of the 
large current account imbalances of the last few years has been a higher growth rate in world 
merchandise trade.  Many countries were willing to  produce and ship more merchandise goods to the 
United States than could be paid for by the sale (e xport) of U.S. products to them, thu s helping fuel 
global trade.  Over the period 2000-08, the U.S. trad e deficit has averaged about 7.2 percent of world 
imports, much higher than its average share of 4.4 per cent during the 1990s.8  The U.S. trade deficit 
has thus represented a hefty source of demand growth to world trade.   
63. A permanent decrease in personal consumption e xpenditures because of the wealth effect (an 
increase in domestic savings ( Sp) will require less foreign savings, holding all other factors constant.  
This means that part of the adjustment to the cu rrent crisis will be a reduction in global imbalances. 
Most projections by international organizations is of a decline in these imbalances.  For example, the 
IMF expects the current account deficit of the Unite d States to shrink to between 2 and 3 per cent of 
GDP in the next five years, after reaching 6 per cent of GDP (see Figure 3).   
                                                      
8 This is based on calculations using UN Comtrade data.  WT/TPR/OV/12 
 Page B-17 
 
 
 Figure 3 
Projection of U.S. current account as share of GDP  
 
Source : IMF World Economic Outlook Database (October 2009).  
64. This prospect raises some important questions for trade as well as for the development 
strategy pursued by a number of emerging econo mies.  Will a rebalancing reduce opportunities for 
economies to rely on export-led growth as a devel opment strategy?  How far can increased domestic 
demand in some large emerging economies such as Ch ina, India, and Brazil, which have not suffered 
as huge a reduction in growth as developed economies, f ill the gap left by the industrial economies?   
65. Many emerging Asian countries have followed ex port-led development strategies.  Some 
studies have characterized this strategy as a response to the problem of rapidly integrating a large pool 
of underemployed labour into the industrial sector. 9 Export led growth and FDI inflows have allowed 
emerging Asian economies to rapidly mobilize and employ  tens of millions of workers.  In return for 
the cross-border transfer of goods and services to the centre country (the United States.), the emerging 
Asian economies have financed the centre country's deficits.   
66. But now with the likelihood of a prolonged w eakness in demand for emerging Asia's exports, 
the source of future growth may need to come from domestically generated de mand.  So far, emerging 
Asia appears likely to exit from the crisis earlier th an other parts of the world, thanks partly to 
government stimulus programmes.  In the medium to  long-term, shifting to a more balanced growth 
model may be in emerging Asia's own self-interest.10  This transformation could be managed in a 
number of ways.  One set of actions will involve  boosting domestic demand.  In the medium to 
                                                      
9 Dooley, Michael P., David Folkerts-Landau, and Pe ter Garber. 2007. "Direct Investment, Rising Real 
Wages and the Absorption of Excess Labor in the Peripher y." In G7 Current Account Imbalances: Sustainability 
and Adjustment, ed. Clarida, Ri chard, 103-132. Chicago: Un iversity of Chicago Press. 
10 Asian Development Bank (2009).  Asian Developm ent Outlook 2009: Rebalancing Asia's Growth.  
Manila: ADB. WT/TPR/OV/12 
Page B-18  
 
 longer-run, emerging Asian governments will need to adopt policies that transfer corporate profits, 
which constitutes the bulk of many emerging Asia n countries' savings, to  households, through for 
example the tax system.  Developing or expanding so cial safety nets can help reduce precautionary 
saving by households.  Measures to improve th e domestic investment climate can increase the 
incentives for savings to be channelled to domestic i nvestment.  Another set of policies will be aimed 
at altering the structure of output so that it beco mes more closely aligned with domestic demand, for 
example by removing policy distortions that favour manufacturing over services, or tradables over non-tradables.  Another set of measures will invol ve accelerating the development of the domestic 
financial system, which will increase its efficiency in allocating savings to domestic investment.  
More flexible exchange rate regimes would help  rebalance growth. Finally, a greater voice in 
international financial affairs may help reduce th e incentive for Asian economies to self-insure against 
future financial crisis by accumulati ng large foreign exchange reserves. 
67. To what extent can rebalanced demand fro m fast-growing emerging economies like China, 
India, and Brazil fill the gap left by the industria l economies?  In purchasing power parity terms, 
Brazil, Russia, India, and China combined are about equal to the size of the U.S. economy.  The four 
countries together account for 22.2 per cent of gl obal GDP while the United States accounts for a 
fifth.
11  Because these emerging economi es are expected to continue to  grow faster than the United 
States, they will represent 27.4 per cent of world out put by 2014 while the U.S. share will decline to 
18.3 per cent.  Thus, it may be possible for them, particularly China, to power global trade growth.  However, some estimates suggest th at even if China’s cu rrent account falls dramatically by half, it 
would add the equivalent of less than half a percentage point to demand in the rest of the world.
12 This 
will not be sufficient to offset the reduction in global growth stemming from lower U.S. and EU 
growth in the next few years.13     
3. Undoing the "great moderation"?     
68. One striking trend in the macroeconomic perfo rmance of industrial countries since the early 
1980s has been the reduced volatility of inflation and th e growth rate of GDP  This trend has been so 
striking that the term, the "great moderation” has b een coined to refer to it.   The first studies to 
document this reduction in volatility were focussed on the United States..14  But later studies have 
shown that this great moderation extended to ot her major industrial economies - France, Germany, 
Italy, Japan, the United Kingdom – as well.15   
69. At least three reasons have been found to expl ain the great moderation.  The first is luck.16  
The world has simply been fortunate during this period  not to have experienced a large adverse shock.  
The second explanation is structural change in economic institutions, tec hnology, business practices, 
or other structural features of the economy that have enhanced its ability to adjust.17  Finally, the third 
                                                      
11 Estimates are derived from the IMF’s World Economic Outlook database (October 2009). 
12 DB Research. 2009. “Responding to the Crisis: Did China and Brazil Miss an Opportunity?” Talking 
point, August 17.   
13 Jäger, Markus. 2009. "Will the BRICs (Read: Ch ina) Really Become the New Global Growth 
Engine?" VoxEU.org, 26 September. http://www.voxeu.org/index.php?q=node/4026. 
14 Kim, Chang-Jin, and Charles Nelson. 1999. "H as the U.S. Economy Become More Stable? A 
Bayesian Approach Based on a Markov-Switching Model of the Business Cycle." Review of Economics and Statistics, 81(4): 608-616.  
15 Blanchard, Olivier, and John Simon. 2001.  "The Long and Large Decline in U.S. Output Volatility." 
Brookings Papers on Economic Activity, 2001(1): 135-164.  
16 Stock, James H., and Mark W. Watson.  2003. "Has the Business Cycle Changed? Evidence and 
Explanations."  Paper presented at the Monetary Policy and Uncertainty Federal Reserve Bank of Kansas 
Symposium, Jackson Hole, WY 
17 Dynan, Karen E., Elmendorf, Douglas W., and Daniel E. Sichel. 2006. “Can Financial Innovation 
Help Explain the Reduced Volatility of Economic Activity .” Journal of Monetary Economics, 53(1): 123-150.  WT/TPR/OV/12 
 Page B-19 
 
 
 explanation is improved m acroeconomic policymaking.18  Economic policymakers have a better 
understanding of the economy.19 They have a greater commitmen t to fight inflation and better 
economic tools to do so with independent central banks being the most powerful of those weapons.        
70. Stability in the global macroeconomic environm ent can enable greater economic integration 
to take place.  Within a country, low rates of in flation and lower output volatility makes for a more 
predictable economic environment that helps c onsumers, producers and investors make better 
economic decisions.  If this stability applies acr oss other countries as well, more cross-border 
transactions are likely to take place holding othe r things constant.  Firms face reduced costs of 
operating in different countries. Firms engaged in international trade will encounter less volatility in 
exchange rates and can operate at a greater scale.  Investors will be subject to less risk when making 
cross-border investments.    
71. With this crisis, the global economy's run of good luck ended. Furthermore, the forceful fiscal 
and monetary response by governments has dram atically increased budget deficits and expanded 
money supplies.  Governments will need to mop up this liquidity and to bring down the stock of 
public debt as the global economy begins to recover.  Otherwise, a long-term threat of inflation will 
hang over the world.   In a fundamental way, the great moderation may have drawn to a close with 
this crisis.  As governments wrestle with the pr oblems of weak household demand, growing public 
debts, and the rebalancing of gl obal demand, the world may be embarking on a more uncertain future 
in terms of macroeconomic policymaking whic h will introduce greater volatility to economic 
outcomes.  One of the consequences of undoing the great moderation may well be a return to a less globalized world.        
B. F
INANCIAL DELEVERAGING AND REGULATORY REFORM  
72. The financial sector has been under severe str ess since the end of 2007 as the profitable but 
highly risky leveraging operations of many banking institutions came  to a disastrous end. In 2007, 
half of U.S. corporate profits came from the fi nancial sector which only accounted for roughly 15 per 
cent of GDP.  The crisis has resulted in a massive process of financial deleve raging, which is putting 
pressure on balance sheets and asset values, threateni ng the solvency of some of the world's largest 
financial institutions, and discouraging fresh lendi ng. While progress to deal with systemic and 
solvency issues have been made in  the past two years, notably through "unconventional" monetary 
policy and fiscal measures applied by central banks and governments, respectively, the balance-sheets 
of commercial banks are being hit by "second-round" effects of this long downturn, i.e. the direct 
effects of shrinking economic growth on loan re-payment.    
73. The process of financial deleveraging has direct effects on world trade through the supply of 
lending for trade (trade credit), which has shrunk with  world trade (even more than trade in certain 
developing parts of the world), and indirect effect s, through the reduction in aggregate demand, linked 
to the credit crunch that is resulting from financia l institution's need to recover proper levels of 
capitalization and liquidity. 
74. Despite efforts made to date, the deleveraging of the international ba nking sector is far from 
over. While the IMF's estimated future write-downs  of assets reached US$4 trillion in the spring of 
2009, based on similar methodology the estimate stood at US$3.4 trillion in the fall of 2009.20 As 
suggested by the IMF on several occasions, the pr ocess of cleansing bank balance sheets is still too 
                                                      
18 Clarida, Richard H., Gali, Jordi, and Gertler, Mark. 2000. "Monetary Policy Rules and 
Macroeconomic Stability: Evidence and Some Theory." Quarterly Journal of Economics, 115(1): 147-180.   
19 Bernanke, Ben S.  2004. "The Great Moderation."  Remarks at the Meetings of the Eastern Economic 
Association, Washington, DC.   
20 IMF (2009), Global Financial Stability Report and revisions. WT/TPR/OV/12 
Page B-20  
 
 slow, though it has made significant progress in the Un ited States and in Europe after full stress test 
exercises.  Efforts to solv e the solvency and liquidity crisis come at a direct cost to the world economy 
since international and local banks will have to be recapitalized or restructur ed in line with losses 
provisioned in their balance sheets. Since it is exp ected that the international banking sector will not 
find all of the capital and liquidity resources they need  in the market, the rescue effort will take a toll 
on public finances and debt in the short-to medi um run. In the short-run also, the issuance of 
government paper will tend to crowd out bank lending, particularly as long as banks have a preference 
for liquidity. Thus, apart from the need to recap italize the banking system, the demand for liquidity 
will also be a factor in sustaining a credit crunch in countries in which the banking system has overexpanded. Until commercial institutions "rebalance"  their maturity structure and strengthen their 
deposit base, the need to roll-over short-term mone y market debt and maturing long-term debt may 
continue to  increase for some time still. 
75. The above considerations all point to the reduc tion of bank balance sheets, rather than an 
expansion of lending.  While the credit crunch may ease with the return of operating profits in the 
banking sector, the world's prudential authorities ar e working within the Financial Stability Board 
(FSB) to restore public confidence in financial in stitutions. The world's depositors and borrowers, as 
well as investors, should be able to assess tran sparently the safety and soundness of financial 
institutions. The FSB has proposed to G-20 leaders a number of rules and guidelines aimed in general 
at increasing the prudential oversight of banks, inv estment firms and insurance companies, notably by 
increasing the transparency of financial instrument s, preventing excessive risk-taking and leveraging, 
applying appropriate accounting rules, strengthening and better enforcing capita l and liquidity ratios, 
strengthening cooperation between supervisory bodies. The prudential upgrade implied by the "re-
regulation" of financial institutions is likely to add to the current requirements on financial institutions 
to be properly capitalized and managed. 
76. While in the short-term prudential upgrade may aggravate the credit crunch, in the medium-
to-long run it will reduce riskiness and improve public confidence in the international banking system. 
The return of deposits to banks will facilitate intermediation and lending. Increased regulatory 
supervision can be positive for globa l integration and trade in the long run if it reduces systemic risk, 
pro-cyclical leverage a nd improve public confidence in the global financial system.  But policy-
makers should avoid changes in regulations that woul d impair the efficiency of the financial system 
and increase the cost of financial transactions wit hout appreciably reducing systemic risk.      
77. Re-regulation should also be applied in a non-di scriminatory manner, and avoid any form of 
"re-nationalization" of lending. Likewise, countri es having provided support to banks, either through 
capital injections, liquidity provision, government loans and guarantees should be able to exit support 
as the deleveraging process takes place, in a way th at does not leave an uneven level-playing field 
between national and foreign-owne d institutions, and even between certain categories of credit and 
others. In this vein, the proper capital adequacy rules under Basle II for trade finance contain some 
flexibility that the G-20 in London has acknowledge d. The use of existing flexibilities would avoid 
undue discrimination against cross-border, short-term  trade transactions, relative to other forms of 
domestic lending that may not be inherently less risky.  
78. All in all, the "re-sizing" of the international fi nancial sector should lead to a re-pricing of risk 
that is more realistic, a re-calibration of financ ial activities towards the real economy and to more 
efficient use of finance. The allocation of savings  to investment should in the end be improved. 
However, it is important that special account of poor countries' banking syst em be taken into account. 
Capital flows to developing countries, be it foreign direct investment or other form of inflows, 
collapsed as a result of the global credit crunch (see Box 1). This is affecting capital accumulation, 
and hence growth, in countries that  need such capital the most.  It  is limiting investments in trade-
related infrastructure that would expand poor countrie s' capacity to trade in th e future.  While in areas 
such as trade finance Tier 1 local banks in emerging countries, which in genera l were in better "shape"  WT/TPR/OV/12 
 Page B-21 
 
 
 than international banks, could substitute for foreig n ones, in low-income countries this is not the 
case. In many instances, the confounding of coun try risk and individual bank risk has fuelled 
unfounded fears of default from perfectly credit-wo rthy local partners. There may be a role for 
international financial institutions to play to correct this "perception gap" which might unfairly 
marginalize countries and institutions  that have gained access to international financial markets and 
the benefits of globalization in the early part of the decade and might lose th em in a "deleveraging" 
process in which they bear little responsibility. One risk of the re-calibration of the international 
financial sector is to impose capital deflation, fi nancial marginalization, and in the end potential 
output reduction to such countries. That would in tu rn affect their ability to reap the benefits of 
international demand when it rebounds.   
Box 1: Shrinking financial flows to developing countries 
In the middle of this financial storm, net private capital inflows to developing countries fell to US$707 billion 
in 2008 from its peak of US$1.2 trillion in 2007 repr esenting a decline of 41 percent.  Prospects for a 
resumption of capital flows to the developing world are dim.  They are projected to fall by half to US$363 
billion in 2009.  Unlike previous crises, the decline in inflows has hit every developing region with emerging 
Europe and Central Asia being hit the hardest.  The growing integration of many developing country 
economies into the global economy ha ve made them much more dependent on private capital flows.  Thus, 
the dramatic contraction of capital flows is expected to have a broader and deeper economic impact on them.  The only silver lining perhaps is that FDI inflows to  developing countries continued to increase in 2008, 
reaching US$583 billion, although almo st all the increase occurred in middl e-income countries, such as the 
Russian Federation, India, Brazil, and China.  
Source: World Bank (2009) Glo bal Development Finance 2009. 
 
 
C. THE ROLE OF THE DOLLAR IN INTERNATIONAL TRADE  
1. Introduction 
79. By some accounts, the United States dollar has been the main currency employed in 
international transactions since at least 1924-26 when it overtook sterling as the leading reserve currency.
21  This was the product of a long and cumulative process.22 The U.S. economy surpassed the 
British economy in size in the late nineteenth centu ry.  But it took the United States until the First 
World War for its exports to overtake British exports and U.S. exports did not obtain a permanent and 
substantial position until WWII.  It was also ar ound the First World War that the United States 
switched from being a net international debtor to a net international creditor while Britain moved in 
the opposite direction.   
80. Evidence of the dominant role of the dollar today is ubiquitous.  Currently, 64 per cent of the 
world's allocated23 foreign exchange reserves are held in U. S. dollars (see Figure 4).  The share is 
probably larger if unallocated fo reign exchange reserves are taken into account. Roughly 88 per cent 
of daily foreign exchange trades involve dollars.  The prices of many primary commodities, including oil, are invoiced in U.S. dollars.  While the euro, wh ich is often touted as a rival to the dollar, is a 
strong second, most transactions involving the euro  are concentrated in the EU and neighbouring 
                                                     
 
21 Eichengreen, Barry, and Marc Flandreau. 2008. "The Rise and Fall of the Dollar, or When Did the 
Dollar Replace Sterling as the Leading International Currency?" NBER Working Paper 14154.   
22 Chinn, Menzie, and Jeffrey A Frankel. 2007. "Will the Euro Eventually Surpass the Dollar as 
Leading Reserve International Currency?"  In G7 Current Account Imbalances: Sustainability and Adjustment, ed. Clarida, Richard, 283 -336. Chicago: Univers ity of Chicago Press. 
23 Allocated foreign exchange reserves are reserv es whose currency composition has been identified. WT/TPR/OV/12 
Page B-22  
 
 countries.
24 Beyond the European continent, euro turnover is  low, at 20 per cent or less. By contrast, 
the share of the dollar is more equally distribut ed across regions. Thus, the dollar functions as a 
vehicle currency globally, while the euro only plays a big role in the European region.  
Figure 4 
Currency composition of (Allocate d) foreign exchange reserves 
0%10%20%30%40%50%60%70%80%90%100%
2002 2003 2004 2005 2006 2007 2008Other
Euro
Yen
U.S. Dollar
 
Source : International Monetary Fund. 
81. Despite the dominance of the U.S. dollar, there are economists who even before the advent of 
the crisis suggested that the dollar's premier status was already in doubt.25 The Chinn and Frankel 
papers point out the United States has a quarter of a century of chronic current account deficits and the dollar has an even longer (35-year) history of tr end depreciation. Furthermore, there now exists a 
potential rival in the euro.  While there are many  possible explanations for U.S. current account 
deficits, one particular explanation is based on the dollar's role as the global reserve currency.  
Although the proposition was meant to apply to the dollar’ s role in the fixed exchange rate system of 
Bretton Woods, the basic dilemma it articulates may have some continuing relevance for today. The 
"Triffin dilemma" states that as the supplier of the global reserve currency the United States needs to 
run persistent external deficits.
26 As world trade and the global economy expands, more reserve assets 
are demanded.  As the supplier of the world's reser ve currency, the United States has no choice but to 
meet this demand through chronic current account deficits. If the U.S. stops running balance of 
payments deficits, the resulting shortage of liquidi ty would retard the development of trade and the 
global economy. However, the dilemma posed by this  is that excessive U.S. balance of payments 
                                                      
24 Cohen, Benjamin J. 2009. "Dollar Dominance, Euro Aspirations: Recipe for Discord?" Journal of 
Common Market Studies, 47(4): 741-766. 
25 Chinn, Menzie, and Jeffrey A Frankel. 2008. "Why  the Euro Will Rival the Dollar."  International 
Finance, 11(1): 49-73. 
26 Triffin, Robert. 1960. Gold and the Dollar Cris is: The Future of Convertibility. New Haven: Yale 
University Press.  WT/TPR/OV/12 
 Page B-23 
 
 
 deficits would eventually erode confidence in the value of the U.S. dollar and undermine its role as 
the world's reserve currency.  
82. The Chinn and Frankel papers point to secular tr ends that may gradually erode the dominant 
status of the U.S. dollar.  Does the advent of the global economic crisis provide a further push to the 
decline in the dollar's international role?  This sectio n explores what factors are likely to determine the 
answer to this question and what the possible implications are for international trade.   
2. Factors determining the international role of a currency 
83. In the domestic economy, money performs several functions: it serves as a medium of 
exchange, a unit of account, and a store of value.   An international currency performs the same 
functions with respect to international transactions  (see Table 3).  In particular, an international 
currency is the vehicle through which transactions between other currencies are made.  This means 
that market participants in countries with their own currencies engage in currency trade indirectly 
using the international currency rather than directly  with their currencies.  This is because certain 
economic characteristics (to be discussed below) of  the country issuing the international currency 
make it cheaper for payments between agents in fo reign countries to be made indirectly using the 
international currency than directly by trading in th eir own currency markets.  Thus, the benefits of a 
vehicle currency is that it saves on transaction cost s and therefore makes possible more exchanges 
than in a world where there is no vehicle currency.  
Table 3 
Matrix of International Currency Use 
Function Private use Official use 
Medium of exchange  Vehicle currency Intervention currency 
Unit of account  Quotation currency Anchor currency 
Store of value  Investment, debt FX reserve currency 
Source : Reisen, Helmut. 2009. "Shifting Wealth: Is the U.S. Dollar Empire Falling?" VoxEU.org, 20 June. 
http://www.voxeu.org/inde x.php?q=node/3672. 
84. In a world with multiple countries each issuing its own fiat currency, any given one of which 
can in principle serve as a vehicle for internationa l transactions, what factors would propel a currency 
to a dominant international role?  The internationa l finance literature suggests at least four important 
determinants.27   
(a) Size of the economy (output, trade and finance) 
85. The currency of a country with a large share in  international output, trade and finance has a 
strong likelihood of becoming the international curre ncy of choice.  On average, the share of 
international transactions involving a particular country  will be equal to that country's share of world 
output.  Thus, the bigger a country's share in world GDP, the more frequently will that country's currency be involved in intern ational economic transactions.
28  
                                                      
27 Krugman, Paul. 1980. "Vehicle Currencies and the Structure of International Exchange."  Journal of 
Money, Credit and Banking, 12(3): 513-526.  McKinnon , Ronald I. 1979. Money in International Exchange. 
Oxford: Oxford University Press. 
28 However, there are exceptions.  For example, onl y a disproportionately small share of trade is 
invoiced in Japanese yen as opposed to dollars which is not consistent with Japan's ranking in world GDP.  This 
may be explained by the fact that most raw materials ar e priced in dollars, most of Japan's imports are oil and 
other raw materials, while much of its  exports go to the United States.  WT/TPR/OV/12 
Page B-24  
 
 (b) Size and depth of national financial market 
86. To attain international currency status, capita l and money markets in the home country must 
not only be open and free of controls, but also deep and well developed. It has also been argued that a 
strong central bank and a large financial sector to counterbalance the political influence of the real 
sector are important. The point is that a large financial sector and a strong central bank will be more 
able to resist political pressure from producers of tradable goods in favour of depreciating the 
currency to help push exports.
29  
(c) Confidence in the value of a currency 
87. To remain attractive as an international currenc y, the value of the currency must be stable, 
and in particular, there must be market confidence that its value will not be depreciated or inflated 
away in the future.  It is important to note that an  international currency would frequently be used as a 
form in which to hold assets by, for example, fi rms holding working balances of the currencies in 
which they invoice, investors holding bonds issued internationally and central banks holding currency 
reserves.30   
(d) Network externalities  
88. Finally, there are "network externalities" involved in the use of an international currency. This 
means that the attractiveness of using a particular  currency in international transactions increases the 
more widely it is employed in international exch ange.  An individual (exporter, importer, borrower, 
lender, or currency trader) is more likely to use a given currency in his or her transactions if everyone 
else is doing so. If a currency is widely used to invo ice trade, it is more likely to be used to invoice 
financial transactions as well. If it is more widely used  in financial transactions, it is more likely to be 
a vehicle currency in foreign exchange trading. If it is used as a vehicle currency, it is more likely to 
be used as a currency to which smaller countries peg, and so forth.31   
89. The presence of network externalities create a form  of inertia in the use of an international 
currency so that it retains its dominant position even if all other determinants (size of economy, size 
and depth of national financial ma rket, confidence in the currency's value) begin to diminish.  For 
example, sterling remained an important internationa l currency even after Britain lost its position as 
an economic power early in the 20th century. In the present context,  this inertial bias favours the 
continued central role of the dollar.  
3. The effect of the financial crisis on the international role of the dollar 
90. One way of examining how the crisis may affect  the international role of the dollar is to 
consider its effects on the key de terminants discussed above.     
91. In the short to medium run, the crisis is likel y to lead to weaker U.S. output growth.  The 
IMF's forecast of average U.S. growth over the ne xt five years is 2.3 per cent while it foresees the 
world as a whole growing by 4.2 per cent over the same period.32  Developing countries are projected 
to do even better at 6.1 per cent, with China expected  to grow at the rate of 9.6 per cent, per annum.  
This implies that while the U.S. will continue to be the biggest economy in the world for some time, 
its relative share of global output will see a marked decline.    
                                                      
29 See the discussion in Chinn and Frankel (2007).  There is also some evidence of this from Frieden 
(2000). 
30 See Chinn and Frankel (2007). 
31 However, see Eichengreen and Flandreau (2008) for a contrary view. 
32 Figures are derived from the IMF's World Economic Outlook database.  
http://www.imf.org/external/pubs/ft/w eo/2009/02/weodata/download.aspx   WT/TPR/OV/12 
 Page B-25 
 
 
 92. In the face of large future U.S. fiscal defic its and the incipient threat of inflation from 
monetary expansion, confidence in the future va lue of the dollar may erode.  A number of central 
banks with large holdings of U.S. dollars have alrea dy expressed such fears.   The origins of the crisis 
in U.S. financial markets may further contribute to this undermining of confidence. 
93. However, given the presence of network extern alities changes in these determinants will not 
necessarily bring about a corresponding change in the in ternational role of a currency, at least not in 
the short run.  The tipping point at which a cu rrency suddenly loses its dominant position may occur 
only after a long lag.  Applying this insight to th e current financial crisis, although there are secular 
forces that may have been working against the dom inant role of the U.S. dollar and which may be 
accentuated by the current  crisis, the dollar n eed not immediately lose its vehicle role.   
94. What does all this portend for the future of intern ational trade?  One possible answer is that an 
international monetary system with multiple majo r currencies rather a single dominant one will mean 
higher transaction costs and more uncertainty in con ducting international trade.  This may reduce the 
scope for more international exchanges. 
95. To sum up, while it is possible to describe the vari ous ways in which the crisis may have done  
collateral damage to the internationa l role of the dollar, it is diffic ult to say, given the existence of 
network externalities, whether this will lead to a ti pping point equivalent to the dethroning of sterling 
in the 20th century.   
D. FRAGMENTATION OF PRODUCTION  
96. The progressive unbundling of the production process33 has played an important role in the 
evolution of international trade in the last half ce ntury.  Goods are increasingly made in two or more 
sequential stages and firms increasingly rely on impor ted goods. More recent developments have seen 
firms not only source input goods from foreign countries, but also offshore office tasks.  This trend explains a large part of the growth in trade in parts and components and of the growth in trade/GDP 
ratio for the last half century as well as th e more recent growth in offshored services.
34 
97. The increasing importance of offshoring35 in international trade is one important channel 
through which the financial crisis  has been propagated to the real  economy and it is an important 
element in explaining the contemporaneous collap se in trade. This subsection first explains how 
international fragmentation of produc tion may have contributed to the collapse in trade flows. Then, it 
addresses the issue of whether business practices may ch ange as a consequence of the financial crisis 
and whether this may lead to a reversal of the process of international fragmentation of production.      
98. There are two ways in which international fra gmentation of production may have contributed 
to the propagation of the financial crisis to the real economy. One is through the so-called 
magnification effect; the other is thr ough a change in business practices.  
                                                      
33 International fragmentation of production, interna tional production sharing or vertical specialisation 
are all terms that have alternatively been used to describe this process. 
34 Hummels, David. 2001."Time as a Trade Barrier." GTAP Working Papers 1152. 
35 There is no agreed definition of the term offshoring. In the context of this subsection we refer to 
offshoring as the sourcing of input goods or services from a foreign country. This definition includes both sourcing from a foreign affiliate through foreign dir ect investment (FDI) and sourcing from a foreign non-
affiliate through arm's lengt h contracts (Helpman, 2006). WT/TPR/OV/12 
Page B-26  
 
 1. The magnification effect 
99. Research on the relationship between trade and GDP growth has showed that the elasticity of 
trade to income
36 has increased over time from around 2 in 196 0s and 1970s to 3.4 in the 1990s and to 
3.7 in the 2000s.37  This implies that trade grows more than three times as fast as GDP.  Assuming 
that crises are not special, this helps to explain wh y trade has fallen so sharply in the current global 
slump.  
100. The increased responsiveness of trade to inco me has been attributed to the increased 
fragmentation of production.  Trade grows faster in a world with offshoring than in a world without 
offshoring because parts and components have to cro ss national borders several times.  In addition, 
international trade declines in a more synchronised way than in a world without vertical specialization 
because the reduction in imports of cars, say follo wing a negative demand shock in country A, is 
reflected immediately in the reduction of exported parts and components that are produced by country 
A. Finally, the decline in trade flows is a multiple of the decline in income, simply because trade is 
measured in gross value whereas GDP is measured in value added. That is, imported tyres embodied 
in a car that is than exported are counted twice in trade statistics. The first time as imports, the second 
time as exports included in the value of the car.     
101. However, as Figure 5 shows, trade has been mo re volatile than GDP during the whole period 
between 1964 and 2008. In addition, much in th e same way as periods of economic recessions have 
been accompanied by faster drops in trade, peri ods of economic boom have been associated with 
faster trade recovery.  
102. To the extent that the severe co llapse in trade that we have observed in the first half of 2009 
simply reflects the increased responsiveness of tr ade to income attributed to fragmentation of 
production, there is no reason to believe that the fi nancial crisis will have permanent effects on the 
level of worldwide trade.  On the contrary we s hould simply expect that as the global economy exits 
the recession, trade will bounce back to pre-crisis levels.  The relevant aspect of the relationship 
between the present economic recession and offshoring is  rather whether there are reasons to believe 
that the attitude toward offshoring will change as a consequence of the crisis, and whether economic 
activity will become permanently  less geographically dispersed.   
2. Change in business practices 
103. In order to understand how the fi nancial crisis may change firms'  attitude toward offshoring, it 
is important in the first place to understand what de termines the decision to offshore and what factors 
explain the increasing international fragmentati on of production over the last half century.  
(a) Firms' decision to offshore 
104. Firms decide to offshore to take advantage of th e benefits of fragmentation.  It might be the 
case that the various stages of production require different types of technology and skills or they may require inputs in different proportions.  Under these  conditions, the benefit of fragmenting production 
across countries is that the firm can locate differe nt stages of the production process in the country 
where there is a relative abundance of the type of skill or input used relatively more intensively in that 
                                                     
 
36 This elasticity is the percentage change in trade corresponding to a one per cent change in income.  
37 Freund, Catherine. 2009. “The Trade Response to  Global Crises: Historical  Evidence.” World Bank 
Working Paper 5015.  WT/TPR/OV/12 
 Page B-27 
 
 
 stage of production.  In so doing, the firm can lower costs of production.38  Offshoring also allows 
firms to smoothen the workload of the regular wo rkforce by contracting-out some tasks in peak 
periods as well as exploiting economies of scale.  
Figure 5 
Growth in the volume of world exports and real GDP, 1964-2009 est.  
(Annual percentage change) 
-15-10-5051015
1964
1966
1968
1970
1972
1974
1976
1978
1980
19821984
1986
1988
1990
1992
1994
1996
1998
20002002
2004
2006
2008
Growth of exports Growth of real GDP 
Source :  WTO Secretariat . 
105. However, fragmentation of production also carries costs.  First, there are costs of searching 
for the appropriate supplier a nd negotiating costs to set up a business relationship between the 
offshoring firm and the source firm. Second, separ ate production stages need to be coordinated and 
monitored.  Therefore, an offshoring firm will in cur transportation and communication costs and other 
connecting services costs to keep the relationship running.  
106. Third, trade costs are magnified. When the di fferent stages of firms' production process are 
geographically spread, producers need to pay fo r moving goods at each stage of the production 
process.  At a given level of trade costs, the more fragmented the production is, the higher the incidence of trade costs on the value of the final product. For example, if the value-added in each 
intermediate production stage is assumed to be in finitesimally small, a 1 per cent tariff increase 
worldwide augments the cost of producing a goo d by N per cent, with N being the number of 
production stages, since between every production st age the intermediate good crosses a border and 
incurs a tariff.
39  
                                                      
38 Jones, R., and Kierzkowski, Henryk. 2001. "Globalization and Consequences of International 
Fragmentation." In Money, Factor Mobility and Trade: Festchrift in Honor of Robert A. Mundell, ed. R. 
Dornbusch, G. Calvo and M. Obstfeld. Cambridge, MA: MIT Press. 
39 Empirical evidence shows that this magnification effect is significant and explains the non-linear 
impact of tariff reduction on trade growth.  In particular, using data for the United States, Yi (2003) shows that 
tariff reductions can explain over 50 per cent of U.S. growth of world trade between 1962 and 1999. WT/TPR/OV/12 
Page B-28  
 
 107. Fourth, there are risks associated with trade-re lated uncertainty, such as uncertainty of timely 
delivery or institutional uncertainty.  For example, the variability of delivery time has an important bearing on the decision to offshore.  The more vari able the delivery time, the greater the buffer stocks 
needed to face demand.  High variability of deliver y time would make it very hard to organize "just-
in-time" delivery, where inventories are kept to a bare minimum and inputs arrive at the factory only 
when they enter the production process. "When just-in-time technology is introduced, delayed 
delivery of a component can hold up the entire production and cause costs that are much higher than the market price of the delayed component.  Ther efore, no discount can compensate the customer for 
unreliable delivery time, and firms with high vari ability of lead time will not be short-listed for 
contracts that require just-in-time delivery".
40 
108. Finally, fragmentation entails a lower degree of flexibility of the production structure. 
Offshoring requires shipping container-size minimu m orders and months-long order cycle times, 
thereby reducing the flexibility and responsiveness of companies’ supply chains to changes in 
economic circumstances. 
109. The decision of whether to offshore and where,  is driven by the trade-off between the 
advantage of lower production costs due to the exploitation of comparative advantage and the 
disadvantage of incurring the additional fragmentation costs. 
(b) Driving forces of increased fragmentation of production   
110. What factors explain the increasing internati onal fragmentation of the production process over 
the last half century?   
111. Technological improvements and regulatory reform explain a significant fall in transport and 
communication costs.  These trends together with tariff reduction have significantly reduced the costs 
of services links in vertically specialised production processes, thus fostering the process of international fragmentation of production.   
112. In addition, reliability and timeliness of deliv ery has improved. Not only has the ten-fold 
decline in air shipping prices since 1950 significan tly reduced air shipping costs, but it has also 
significantly reduced the cost of speed.  This has ha d two major effects.  First, shipping times have 
been falling over time, so has the time cost of trad e.  The average shipping time to the United States 
declined from 40 to 10 days between 1950 and 1998.
41  Evaluated at an average cost per day of 0.8 
per cent ad valorem , the use of faster means of transport is  equivalent to reducing tariffs by 24 per 
cent.42 Second, costs related to the uncertainty of time ly delivery have fallen. Improved infrastructures 
and logistic services are in this respect two additional factors explaining this trend.  
113. Finally, IT advancements made it possible to  separate geographically an increasing number of 
services tasks.  An obvious pre-condition for offshoring (and, in general, for outsourcing) tasks is that 
the production of a particular input or a particular ser vice task is separable and tradable.  In this sense, 
technological innovation has been a driving force for the recent phenomenon of services offshoring.  
In fact, recent technological deve lopments, especially in IT, have  made it possible to separate 
geographically an increasing number of services tasks.  Basically, services such as accounting, 
bookkeeping, payroll and others that relate to the collection, manipulation and organization of 
information can be codified, digitalized and sep arated from other activities within firms.  The 
                                                      
40 Nordas, H. K.  2007. "International Production Sharing: A Case for a Coherent Policy Framework." 
WTO discussion papers 11. 
41 The shipping time is the weighted average of o cean shipping and air freight.  See Hummels (2001). 
42 Hummels, David.  2007. Transportation Costs and International Trade in the Second Era of 
Globalization. The Journal of Economic Perspectives, 21: 131-154.  WT/TPR/OV/12 
 Page B-29 
 
 
 possibility of transmitting information electronically via the internet, for example, has rendered these 
services tradable, thus making them candidates for offshoring.  Similarly, automation has been a 
driving force in the development of a production network in the automotive industry because it has 
made it easy to transfer technology by standardizing a certain stage of production.   
(c) Are these trends likely to change?  
114. As discussed above, the increasing fragmentation of production is to a large extent driven by  
recent technological advancements that have re duced trade costs as well as made some services 
tradable and improved timeliness of delivery.  It is hard to think of a reversal in technological know-
how that would rollback these advances.  Therefore, in this respect, it may confidently be argued that 
offshoring is here to stay.  
115. There are however changes in the attitude of  businessmen toward offshoring that may be 
expected in the future.  Some of these changes may be related to the crisis.  For example, when GDP 
falls, governments may be tempted to turn to protec tionist policies in the attempt to shield their 
country from the crisis.43  If the increase in tariffs and NTBs arisi ng from the crisis persist even after it 
ends, higher trade costs will make offshoring less profitable, thus reduc ing vertical specialisation.   
Another example is that the experience of a crisis may change businessmen's perception of the risks 
related to offshoring.  Producers may realise that th ey underestimated the risks of tariff increases, or 
risks associated with the lower flexibility of vertically  specialised rather than integrated supply chains 
to changes in the economic environment.   
116. Other factors not related to the crisis may also  affect firms’ propensity to offshore in the 
future.  The business literature claims for example th at “the offshoring cost advantage may have never 
really been that high and likely significan tly less when ‘all-in’ costs are considered”.44  Manufacturing 
executives simply have been learning over time that  offshoring costs (including costs of resolving 
quality problems, delivery delays, reduced flexibility of companies' supply chains, reduced ability to 
customise the product to local markets, etc.) are actually higher than firms had expected.  As a consequence, they will reduce fragmentation of production.   
117. Another important factor is the oil price.  Th e increase in the oil price experienced between 
2003 and 2008 has been reversed by the crisis, but  when the global economy recovers the world may 
experience a permanent increase in oil prices.  Given the importance of the oil price in transport costs 
as well as the importance of transport costs in th e decision to offshore, a higher oil price may 
significantly undermine the benefits of offshoring.  
118. Finally, environment-related policy changes or a changed sensitivity of consumers to 
environment-related problems may affect the deci sion to offshore.  When production chains are 
geographically fragmented, goods travel long distances. Therefore, ceteris paribus  internationally 
fragmented production is associated with higher nega tive environmental effects than local production. 
If environment-concerned consumers are willing to pay a higher price for locally produced goods, the 
benefits of offshoring will go down.  Therefor e, producers will choose to source their inputs or 
services locally.
 45  
                                                      
43 See WTO Monitoring Reports.  
44 Ferreira J., and Len Prokopets. 2009. "Does Offshoring Still Make Sense?" Supply Chain 
Management Review. January 1.  http://www.scmr.com/article/CA6628648.html.  
45 Producers will also choose to source inputs locally if  they are made to pay the cost of the negative 
environmental effects of offshoring. WT/TPR/OV/12 
Page B-30  
 
 3. Implications for developing countries 
119. The decision to offshore is intimately linked with the decision of where to offshore.  There are 
country-specific costs that may hinder a country's participation in interna tional production networks 
and services offshoring.  The economic literature has hi ghlighted - together with the traditional factors 
of comparative advantage, such as factor prices, sk ills availability and the tax regime - new sources of 
comparative advantage that determine where a firm chooses to offshore.  These include the quality of 
the institutional framework in enforcing contracts, quality of infrastructure, the size of the market 
(which determines how easy it is to search for appr opriate suppliers) and any ot her factor that reduces 
the cost of offshoring (e.g. a reduction in the time to start up a business).  
120. Government responses to the present crisis have  highlighted another issue that may in the 
future affect firms' decision of where to offs hore: a country's ability and willingness to provide 
subsidies.  The growth of global supply chains has made it more difficult for governments to raise 
tariffs without harming producers in their own country. When governments impose tariffs, global 
supply chains amplify their effects, because compon ents and part-finished items have to cross the 
border several times.  Similarly, the negative effects on trade of non-tariff barriers are amplified with 
offshoring.  Grossman
46 cites the intensive use of subsidies by  some countries during the crisis as 
evidence that international fragmentation of pr oductions has changed the political economy of 
protection.  Firms no longer lobby for direct protection because they import much of the components for their final output, they prefer to lobby for exp licit subsidies.  However, not all governments may 
respond to the pressure to use subsidies. The provisio n of subsidies is costly and governments need to 
have adequate resources to provide subsidies.  Th is means that developed countries will be better able 
to provide financial support to their industry th an developing countries.  The concern with the 
asymmetric use of subsidies is that they could cause some stages of production to switch from developing countries back to devel oped countries.  Anticipating that governments in rich countries are 
more likely to support the private sector using s ubsidies rather than tariffs in case of adverse 
economic circumstances, firms may choose to relo cate some of their stages of production from poor 
to rich countries.  
121. Another reason why firms may decide to relocat e some of the stages of their production chain 
away from some developing countries may also be re lated to environmental c onsiderations.  First, 
access to environmentally friendly technology may be an  important factor in a firm's choice of where 
to source inputs from.  Second, distance to the final market may also play a role. If firms will be able 
charge higher prices for products that are produced in less efficient plants but ar e located closer to the 
final market, they will choose to source from nea r-shore. Consumers' preferences for goods produced 
in a way that minimize carbon footprint may not only affect the number of stages into which production will be fragmented (as me ntioned above), but also the choice of the source country.   
122. In addition, distance-related considerations ma y also matter in the perception of the risks 
associated with a reduced flexibility of the suppl y chain under offshoring. The risk for some 
developing countries may be that manufacturing an d supply networks migrate back to near-shore, 
such as Canada and Mexico for U.S. manufacturers or Eastern Europe for European manufacturers.  
4. Conclusions 
123. International production sharing is explained by differential wage/productivity ratios in 
alternative production locations and made possibl e by technological improvements and regulatory 
reform.  But the economic calculations about the attractiveness of alternative production sites can 
easily change as a result of shifts in underlying business relationships, increased protection, different 
                                                     
 
46 As cited in the article by The Economist titled "T he nuts and bolts come apart" (26th May 2009 
issue).  WT/TPR/OV/12 
 Page B-31 
 
 
 perceptions of risk associated with alternative lo cations, and consumer preferences that shift towards 
national production.  In addition, there may be a learning effect as a result of which producers 
discover unanticipated production or managerial cost s associated with off-shoring.  Some of these 
effects may be crisis-related, but some may be of a pe rmanent nature.  Therefore, the risk exists that in 
the future we may see a reversal of the process of  international fragmentati on. In particular, the 
changed political economy of protection for verti cally specialised production networks may play a 
role in causing some stages of production to switc h from developing countries back to developed 
countries. 
E. CHANGING PUBLIC ATTITUDES TOWARD GLOBALIZATION  
1. Introduction 
124. Changes in public attitudes may have long lasti ng effects on public policies and, therefore, on 
social welfare.  An observer in 1875 would have  thought that globalization was an unstoppable 
process led by technological progress.  However, the process stopped because of a change in public 
sentiments towards international trade and cross-bor der migration which led to a political backlash.47 
125. Individual attitudes are a primary determinant of final policy outcomes through voting or 
other forms of political participation.  A worseni ng in public sentiments towards globalization in some 
countries may well lead to policy restrictions in th ose economies which, in turn, trigger protectionist 
responses by trading partners.  In other words, a process of de-globalization may in principle be initiated by a switch in public attitudes in a part of the global economy.  For this reason, what 
determines the perceptions (or change in percepti ons) on international econom ic integration and how 
these sentiments will be affected by the current economic crisis are essential questions for policy 
makers. 
2. Recent surveys on attitudes towards globalization 
126. Several institutions have collected data ove r time on public attitudes towards trade and 
immigration.  While there is some understandabl e heterogeneity in the findings based on these 
different sources, which generally reflect differe nt methodologies, some common trends seem to 
emerge.  First, attitudes towards trade are generally  positive, but have worsened in recent years in 
several developed countries.  Second, attitudes towa rds immigration appear to be more stable over 
time.  Third, people tend to be more anti-immigration than anti-trade.   
127. Figure 6 reports data from the Pew Global Attitud es Project.  It shows that the percentage of 
people that believe that international trade is bad is  low in most areas of the world.  However, this 
percentage has increased between 2002 and 2007 in f our out of six regions, most notably in North 
America.  
128. It may be too early to infer the effect that the economic crisis has ha d on public attitudes and 
we lack world-wide surveys.  However, some  recent opinion polls in a number of advanced 
economies provide some preliminary insights.  Fi rst, a Financial Times/Harris Poll of March 2009 
(see Table 4) finds that in the United States and in the United Kingdom a higher percentage of 
respondents believe that trade protectionism can he lp their economy recover from the recession.  The 
opposite is true in large continental European economies.
 48  
                                                      
47 O’Rourke, K. H., and Jeffrey G. Williamson. 1999.  Globalization and History: The Evolution of a 
19th Century Atlantic Economy. Cambridge, MA: MIT Press. 
48 However, note that the question posed to European respondents does not distinguish between intra-
European trade and trade with  the rest of the world. WT/TPR/OV/12 
Page B-32  
 
 Table 4 
Would protectionism help end the recession? 
Percentage of 
respondents who: United States Germany Spain France United 
Kingdom Italy 
Agree 30 16 22 23 28 53 
Disagree 24 30 30 36 23 34 
Source : Financial Times/Harri s Poll, Harris Interactive, March 19, 2009 
129. Figure 7 shows for the same regions and the same years the percentages of respondents who 
have a negative perception of immigration.  Attitu des towards immigration are consistently more 
stable and more negative than attitudes to trade.   
Figure 6 
Average percentage of people believing growing trad e and business ties with other countries is somewhat 
or very bad 
0%10%20%30%40%
2002 2007 2002 2007 2002 2007 2002 2007 2002 2007 2002 2007Africa Middle E ast North America Southeast Asia Southern E U & E astern E ur.% of Respondents
0%4%8%12%16%20%
Average Regional GDP Growth
Tr a de  -  S o m e wh a t  ba d Tr a de  -  Ve ry  ba d T rade - Average GDP 
Source:   Pew Global Attitude Project,"World Publics We lcome Global Trade--But Not Immigration," 
4 October, 2007 . 
  WT/TPR/OV/12 
 Page B-33 
 
 
 Figure 7 
Average percentage of respondents believing immigrants  have a somewhat or very bad influence on their 
country 
0%10%20%30%40%50%60%
2002 2007 2002 2007 2002 2007 2002 2007 2002 2007 2002 2007Af r i c a EU  & Ea s t e r n  Eu r . Mi ddl e  Ea s t N o r t h  A m e r i c a S o u t h e a s t  As i a S o u t h e r n  A m e r i c a s% of Respondents
0%4%8%12%16%20%
% GDP Growth
Immigrants - Somewhat bad Immigrants - Very bad Immigrants - Average GDP 
Source : Pew Global Attitudes Project, "World Publics Welcome Global Trade--But Not Immigration," 
 4 October 2007. 
130. A second poll by the Pew Research Center see ms to have a more positive outlook for the 
United States.  They find that, despite the ec onomic crisis, in April 2009 the percentage of 
respondents that believe that international trad e (i.e. trade agreements such as NAFTA and the 
policies of the WTO) are bad for the country is 35 per cent, down from 48 per cent in April 2008.  While this finding may seem reassuring, one has to keep in mind that 2008 was an election year where 
trade issues were an important part of a heated politi cal debate.  As shown in Table 5, also from Pew, 
between 1997 and 2009 there is a clear positive long-r un trend in the percentage of people in the 
United States that have anti-trade sentiments. 
Table 5 
In general, do you think that free trade agreements like NAFTA, and the policies of the World Trade Organization, have been a 
good thing or a bad thing for the United States? 
Percentage of 
respondents who find 
Free Trade Agreements and  WTO a: Sept 
1997 Sept 
2001 Dec 
2003 July 
2004 Oct 
2005 Dec 
2006 Nov 
2007 April 
2008 April 
2009 
Good thing 47 49 34 47 44 44 40 35 44 
Bad thing 30 29 33 34 34 35 40 48 35 
Don't know 23 22 33 19 22 21 20 17 21 
Source :  The Pew Research Center, NEWS Release, April, 28, 2009  
131. We do not have surveys that compare the opi nions on immigration before and after the 
economic crisis.  However, Boeri ( 2009) compares a question asked by the European Social Survey in 
2002 that closely resembles a question of the FT/Harr is poll of March 2009.  Both surveys essentially 
inquired whether immigrants should be made to leave the country if they lose their job.  As reported WT/TPR/OV/12 
Page B-34  
 
 in Table 6, the percentage of respondents that agree with the statement has increased in all large 
European countries (on average an increase of 27 per cent).   
Table 6 
Should unemployed immigrants be made to leave? 
Percentage of respondents 
agreeing with the statement Germany Spain France United Kingdom Italy 
ESS 2002 50 25 32 53 49 
Harris 2009 67 71 51 78 79 
2002-2009 +17 +46 +19 +25 +30 
Source :  European Social Survey, 2002, and Financial Ti mes/Harris Poll, Harris Interactive, March 19, 2009 . 
3. Determinants of attitudes to trade 
132. Opinion polls and surveys such as the ones discu ssed in the previous section provide a useful 
picture of current trends in public sentiments on gl obalization.  However, while one can speculate on 
the determinants of changing trends, a rigorous econo metric analysis is necessary to disentangle the 
different effects.  This and the next section review  the key findings of a rece nt economic literature that 
studies the factors that affect public perceptions to trade and immigration.  
133. What determines public attitudes to trade?  Recent studies show that a combination of 
economic and non-economic factors influences individual perceptions.   
134. Among the economic determinants, trade prominen tly affects attitudes through its effects on 
labour markets.  The well known Heckscher-Ohlin model of international trade predicts that countries 
with different labour endowments  gain from opening their economies, but trade will affect income 
distribution.  In particular, in countries where the labour force is mostly low-skilled the better 
educated will see a decline in their relative wage, while the opposite  is true for the less skilled 
workers.  Similarly, in countries that are abundant  in high-skilled workers, less educated workers will 
experience a decline in their relative wage and the high-skilled an increase (Stolper-Samuelson 
theorem).   
135. Consistently with this basic insight, recent econometric analysis finds that in low skill-
abundant countries, the better educated tend to be an ti-trade, while the less educated are pro-trade.  
Public perceptions are the opposite in high-skill ab undant countries, where the better educated are 
pro-trade and low-skill workers oppo se trade.  These effects continue to be large and statistically 
significant when a number of non-economic contro l variables (such as age, gender, nationalistic 
political sentiments) are included in the econometric analysis. 
136. An important question is how economic uncertain ty affects trade sentiments.  A recent study 
finds that job uncertainty has a strong and positive effect on anti-trade attitudes.49  That is, all things 
being equal, if workers fear that they might lose their jobs, they will be more likely to oppose 
international integration.  Inter estingly, this study also finds that domestic policies that reduce 
economic uncertainty, such as social safety nets , welfare programs or government spending that 
increases public employment, improve pro-trade attitudes.   
                                                      
49 Mayda, A. M., Kevin H. O'Rourke, and Richard Sinnott. 2007. "Risk, Government and 
Globalization: International Survey Evidence." NBER Working Papers 13037.  WT/TPR/OV/12 
 Page B-35 
 
 
 4. Determinants of attitudes to immigration 
137. The previous section discussed the factors that influence public opinions on trade.  In this 
section, we look at the other side of international integration: the cross-border movements of people.  
What determines public attitudes to immigration in receiving economies? 
138. Economic theory predicts that movements of people (as well as other factors in production) 
across national borders have effects very similar to  international trade.  Overall freer immigration 
increases national welfare, as labour moves where reward s are larger (i.e. where it is most needed).  
However, this affects the distribution of income wi thin countries.  Consistently, studies that analyze 
attitudinal responses in survey data sets find that in countries where natives are more skilled than 
immigrants, the skill level is positiv ely correlated with pro-immigrati on attitudes.  The opposite is true 
in countries where the native labour force is predominantly low-skilled. 
139. A second result that emerges from the literature on immigration is that the size of welfare 
programmes is an important determinant of public sentiments in receiving economies.  In countries 
with larger welfare states and proportional taxa tion, low-skilled immigrants contribute to the 
government budget less than what they receive in  terms of services (e.g. health, schooling for 
children) and transfers (e.g. unemployment benefits).  As a result, immigration is expected to increase 
the cost of welfare programs.  Due to proportional tax sy stems, this cost is paid to a larger extent by 
wealthier native citizens.  Consistently with the theory, recent studies find that income is negatively 
correlated with pro-immigration preferences in countries where natives are more skilled than 
immigrants (i.e. in advanced economies).  
140. As discussed above, individuals across the worl d are more anti-immigration than anti-trade 
(compare Figure 6 and Figure 7).  There are three complementary explanations  that have emerged in 
the literature.50  First, while labour market effects are sim ilar as discussed above, there is an important 
element of divergence.  Workers in the non-traded sectors feel shielded from foreign competition that 
works through trade, but not from the competition in the labour market coming from immigrants.  
Second, trade and immigration affect public finances  in very different ways.  The (potentially large) 
effects of low-skilled immigration on welfare sy stems may contribute to explaining the weaker 
opposition to trade.  Finally, similarly to attitudes to  trade, a large number of non-economic individual 
characteristics influence the percep tions that respondents have of immigration.  These cultural and 
social factors, however, seem to be consisten tly more pronounced in shaping immigration attitudes 
relative to trade.  
5. Public perceptions on globalization and the crisis 
141. The empirical evidence discussed in the previous  two sections highlights the role of economic 
determinants of public sentiments towards trade and immigration.  Interestingly, these empirical 
findings support the idea that globalization implies a policy trilemma , that is a form of "impossible 
trinity". Open trade, open immigration and a welfare system are hard to reconcile, notably in advanced economies.  
142. Sustaining positive attitudes to open trade requi res safety nets and welfare programs that 
lower the negative consequences of economic uncerta inty.  However, a welfare system raises the 
fiscal costs of (low-skilled) immigration and wo rsens anti-immigration sentiments of natives in 
receiving economies.  If, on the other hand, public spending in welfare programs is low, the hostility to immigration is lower but the lack of protection in the face of growing uncertainty induces voters to 
oppose trade openness. 
                                                     
 
50 Mayda, A. M. 2006. "Who is Against Immigratio n? A Cross-country Investigation of Individual 
Attitudes Toward Immigrants." The Review of  Economics and Statistics, 88(3): 510-530. WT/TPR/OV/12 
Page B-36  
 
 143. How will the economic crisis affect public attit udes towards globalization?  While we do not 
have a definitive answer, we can attempt some speculation based on the findings discussed above.  
The response of attitudes to the crisis will likely depend on what side of the policy trilemma countries 
are located.  An economic downturn is associated with  an increase in uncertainty, such as the rise in 
the probability of becoming unemployed or the surge in other forms of economic risks, which may 
drive up negative perceptions of globalization.  Th is, however, could take place in an asymmetric 
form:  voters may turn more protectionist in c ountries with "smaller" welfare systems, while anti-
immigration sentiments may rise in economies with "larger" welfare programs.    
144. A final issue deserves further attention:  the effect that the economic crisis has on policy 
restrictions through a change in public attitudes.  As voters' perceptions are a key determinant of 
policy outcomes, worsening negative attitudes may lead  to policy restrictions.  Will these restrictions 
be structural or cyclical?  The answer is not obvious.  As uncertainty declines, perceptions on 
globalization may improve and trade and immigration barriers will be re duced.  However, restrictions 
and negative attitudes may be persistent as they both ar e sticky downward, that is they tend to be hard 
to undo once they are imposed.
51   
6. Conclusions 
145. This part of the report has investigated how th e economic crisis may affect voters' attitudes to 
international integration.  The data shows that anti-immigration sentiments  are high everywhere and 
generally stabilize over time.  On the other hand,  trade attitudes are more positive, showing an  
improvement in developing countries, but gra dually worsening in more advanced economies. 
146. A recent empirical literature shows that globa lization influences public perceptions through 
its effects on income distribution and uncertainty.  These effects may be responsible for the gradual 
rise in anti-trade attitudes in some countries, partic ularly where welfare programs (that redistribute the 
gains from trade and lower the economic risks asso ciated with trade opening) are weaker.   
147. The crisis has introduced greater uncertainty  and is likely to worsen attitudes towards 
globalization. In countries where welfare systems ar e less developed, the changing mood may take the 
form of anti-trade sentiments, while voters' opposition to immigra tion may rise in economies with 
larger governments.  If more negative attitudes lead to trade policy restrictions, these barriers may be 
difficult to reverse once in place.   
148. Finally, governments have responded to the ec onomic crisis by boosting public spending and 
revitalizing welfare programmes.  In the immediate term, these interventions save jobs and reduce 
economic uncertainty.  In the longer term, they cr eate confidence that open markets do not necessarily 
mean more risk, and therefore help fortify voters' support for trade opening.   
F. OTHER LONG -TERM CHALLENGES  
149. Beyond these factors, there are also other long-term challenges such as climate change, 
scarcities in food, energy and natural resources, and new private standards that are likely to confront 
the global economy and the multilateral trading system.       
                                                      
51 Fernandez and Rodrik (1991) show that policy may suffer from a status quo bias.  Once barriers go 
up, trade opening may be difficult as people are uncertain  about how they will be affected by it.  Giordani and 
Ruta (2009) argue that negative attitudes may be self-fulf illing and that it will be difficult to revert to the initial 
state as restrictions may lock in the economy to an in efficient equilibrium.  (See Fe rnandez, R., Dani Rodrik. 
1991. "Resistance to Reform: Status Quo Bias in th e Presence of Individual- Specific Uncertainty." The 
American Economic Review, 81(5): 1146-1155.)  WT/TPR/OV/12 
 Page B-37 
 
 
 150. One development that may become more importa nt in the future is the use of private 
standards.  They are partly a response by firms to  changing consumer preferences and partly a way to 
make their production more efficient.  Private stan dards are a way for firms to appeal to consumer 
concerns about the environment (organic foods), equity  ("fair trade") and health (genetically modified 
foods).  Private standards are also a way for produ cers to manage the globalization of production, with 
supply chains that straddle countries or even con tinents, and long complex distribution systems.   
Standards form part of producers' quality control systems.  However, the proliferation of private standards and, in the end, of many competing standards for the very same products, could reduce 
economic efficiency.  This could end up hampering the attainment of the environmental, safety, and 
other regulatory goals that these standards may be de signed to achieve.  In addition, private standards 
may occasionally arise from a desire to restrict competition and trade.   While WTO rules have 
focused on government mandated product standards (technical regulations), most new standards are 
likely to be generated by private firms and industries.  What this portends is that an increasingly larger 
part of international trade will be subject to st andards that are only impe rfectly disciplined by 
international trade rules.     
151. A sudden spike in food prices in 2008 focused  the world's attention on the markets for 
primary commodities.  Since 2003, there has been a robust upswing in the prices of food, energy and natural resources.  This rise is explained by variet y of different factors, such as the rising price of 
energy, droughts, the increased production of biofuels from foods, and rising demand for food in some emerging economies. High energy prices have made agricultural production more expensive by 
raising the cost of inputs like fertilizers, pesticid es, and transportation services.  As energy prices rose, 
concerns about energy security prompted governments to encourage the production and use of bio-
fuels. This has led to a shift in cultivation aw ay from commodities which have predominantly been 
used as food towards bio-fuel feedstock.   
152. Rising primary commodity prices have benefite d many developing countries who are primary 
commodity exporters.   But a number of food-importing developing countries have also been severely 
affected by the spike in food prices.  One concern has been the use of export restrictions which may 
occasionally have exacerbated scarcities in world markets.  For the moment, the financial and 
economic crisis has put a stop to rising primary commodity prices.  But once the global economy recovers, and given the projected return of emer ging economies to robust growth, we may swiftly see 
the world reverting back to the trend of rising food, energy and natural resource prices.     
153. Finally, with the possible exception of the ec onomic crisis, there is no bigger issue on the 
international agenda than climate change.  Th e consequences for humankind of rising global 
temperatures have been amply described and analysed in the most recent report of the Intergovernmental Panel on Climate Change.
52  One notable point that is not emphasized often 
enough in the discussions is that climate change ca n affect the pattern and volume of international 
trade flows. Climate change can increase the vulne rability of the supply, transport and distribution 
chains upon which trade depends thereby increasing the cost of international trade.  Rising average 
temperatures and increasing frequency of extreme weather events can lead to shifts in the 
geographical pattern of production and hence in the di rection and volume of international trade flows. 
This effect will be stronger in those countries w hose comparative advantage stems from climatic or 
geophysical factors.  Countries that are unprepared for these climatic changes, which most likely will 
be the poorest countries, may face enormous trade adjustments.  
154. However, it is vital not to lose sight of the pos itive role that international trade can play to 
both mitigate climate change and to help countries adapt to its consequences.  Trade serves as a 
channel for spreading goods, services and technologi es that reduce greenhouse gas emissions.  This is 
                                                      
52 IPCC. 2007. Climate Change 2007: Impacts, Adaptation and Vulnerability. Cambridge: Cambridge 
University Press. WT/TPR/OV/12 
Page B-38  
 
 the contribution that the liberalisation of envi ronmental goods and services in the Doha Round can 
make to the effort to mitigate climate change.  In addition, trade can help bridge differences in 
demand and supply conditions that may arise as a r esult of changes to the geographical patterns of 
production from climate change.       
155. One key worry would be a failure by governme nts to achieve international agreement on how 
to tackle climate change.  This can have serious  repercussions on interna tional cooperation in other 
fields, including trade.  It can lead countries to  the unilateral use of trade measures as a way to 
alleviate their domestic industries' concerns about the effect of cl imate change mitigation measures on 
competitiveness or as a way to strategically influe nce the environmental policy pursued by their trade 
partners.  In effect, the absence of an interna tional environmental solution may spill over into the 
trade arena, creating trade tensions and reducing th e potential growth of international trade.    
IV. CONCLUSIONS 
156. The report has examined a number of shaping f actors that are likely to affect the future 
evolution of international trade.  A number of th ese shaping factors are going to continue to provide 
forward momentum to trade. The technological cha nges that made possible the economic integration 
of nations will not be reversed and is likely to co ntinue to reduce the cost of conducting international 
trade.  Regulatory reform that reduces systemic risk  in the global financial system and makes it more 
robust will improve the allocation of savings and the rate of economic growth.  But other factors are 
likely to weaken the forces of economic integration.   The wealth effect from the massive destruction 
of financial and home values will be a big drag on global consumption. The empirical literature 
indicates that the magnitude of this wealth effect  will be significant.  Some of this reduction in 
consumption demand is manifesting itself in pa rt in smaller current account imbalances. The 
rebalancing of demand and production in emerging countries may not be sufficient to fill the gap left 
by households in rich countries.  Furthermore, th e crisis has introduced gr eater economic uncertainty 
and is likely to worsen public attitudes towards globali zation.   The impact of other shaping factors is 
more difficult to predict.  The economic calculations  about the benefits and costs of offshoring can 
easily change because of increased protection, different  perceptions of risk associated with alternative 
locations, and consumer preferences towards na tional output.  The changed political economy of 
protection that has favoured the use of subsidies may cause some stages of production to switch from 
developing countries back to developed countries.  Wh ile the current crisis and the anticipated higher 
fiscal deficits may lead to a desire to shift away  from the U.S. dollar, network externalities could 
preclude such a shift in the short to medium term.      
157. But whether cyclical or secular forces are at  work, there are certain steps governments could 
take now that could help revive  international trade flows and st rengthen the international trading 
system.   
158. Macroeconomic policies would need to be s upportive given the current weakness in private 
demand.   They also need to dovetail with the effort  to revive international trade.  This means that 
existing and future policies must be designed so th at they are non-discriminatory and do not favour 
home suppliers relative to foreign suppliers. As  global imbalances are unwound, export-oriented 
emerging economies will need to depend more on dom estic sources of growth.  Although it is easier 
said than done, policymakers must be ready to withdr aw stimulus and liquidity in an orderly fashion 
once the recovery gains solid footing.    
159. Regulatory changes in the financial sector shoul d be applied in a non-discriminatory manner. 
Countries that have provided support to their financial sector during the crisis must ensure that as part 
of their exit strategy it does not leave an uneven level-playing field betw een national and foreign-
owned institutions.    WT/TPR/OV/12 
 Page B-39 
 
 
 160. Given the expected huge shortfalls in private capital flows to developing countries, 
multilateral, regional and bilateral donors must step up their efforts to deliver and expand aid for 
trade.  By providing resources to build the trade-re lated skills and infrastructure that are vital to the 
integration of the poorest countries into the internati onal trading system, aid for trade will help these 
countries recover from an economic crisis that they had no hand in creating.  
161. With unemployment likely to continue to ri se until at least next year, increasing social 
spending would help avert a looming social crisis.  In developed countries that have been hard hit by 
the financial crisis, social protection systems are a valuable mechanism for underpinning public 
support for open trade.  It is also valuable in a nother context as a mechanism to assist rebalancing of 
global demand since the lack of social protection systems in emerging economies has been raised as 
one of the reasons for why households th ere have high precautionary savings.  
162. While one cannot rule out worsening employ ment conditions triggering more demand for 
trade restrictions, on the whole, the system of WTO rules have held up well in the midst of the crisis.  There has been no systemic breakdown in the inte rnational trading system and WTO members have 
resisted the allure of protectionism.  As the wors t effects of the crisis recede, WTO members must 
begin to remove whatever trade-restrictive meas ures they have been taken, in response to the 
economic downturn, including subsidies and other forms of state assistance. 
163. Whether it is in the context of exiting the crisis, or facing up to future scarcity in food, energy 
and natural resources, or dealing with climate ch ange, open markets provide the best way for the 
international trading system to contribute to a solution.  Beyond quickly dismantling protectionist measures, WTO Members need to push for greater market opening.  The Seventh WTO Ministerial 
Meeting provides an opportunity for members to commit to concluding the Doha Round by 2010.   
 
__________