ownership of suppliers (through foreign direct investment) is more likely, and in which supplier contracts are of longer duration.

# **3.  The Role of GVCs in the Collapse of World Trade, 2007-2009**

## **3.1 Cyclicality and the “Composition Effect”**

Why did trade volumes collapse so dramatically relative to GDP in the recent downturn? Freund (2009) shows that historically trade flows are pro-cyclical and follow a more exaggerated cyclical pattern than GDP. She analyzes the effect on the value of international trade of global economic downturns in 1975, 1982, 1991 and 2001, and finds that global economic downturns in the recent past have, on average, been associated with declines in the volume of world trade proportionally greater than the change in GDP. On average over these downturns, GDP growth fell to 1.5% and the growth in trade value turned negative, to -1.0%. In the year leading to the trough of the cycle, she finds the percentage point fall in trade is five times that of world output. By this standard, if world GDP in the recent recession falls by 4.8 percentage points, then world trade will fall by over 20 percentage points. Importantly, Freund (2009) also predicts that the GDP-trade relation is symmetric, i.e. that the rebound in trade is greater than the rebound in GDP and that the recovery of trade is as fast as was the decline in trade. Most of the trade rebound occurs the same year as the GDP growth increase, but “it takes about 4 years for trade to pass pre-downturn levels” (Freund, 2009, p. 8). According to the WTO, the 2010 trade rebound should help recover some, but not all, of the 2009 trade losses that occurred when the global crisis prompted a 12.2% contraction in the volume of global trade; the WTO forecasts that, should trade continue to expand at its current pace, it would take at least two years in developing countries, and three years in developed countries, for trade volume to surpass the peak level of 2008.<sup>7</sup> One reason trade reacts more strongly to changes in GDP during a recession than otherwise is the difference in the composition of trade and GDP. In a global downturn the demand for goods falls more strongly than the demand for services, because goods represent the bulk of trade flows, while services make up the bulk of GDP. In particular, the demand for “postponeable” goods – consumer durables, and investment goods related intermediates, which make up a narrow slice of world GDP, but a large percentage of world trade – dropped sharply during the crisis. Thus the global crisis operated with full force on trade, but with less force on GDP as a whole.<sup>8</sup> Evidence of the composition effect is confirmed in _Figure 4_ , showing the sharp decline in “industrial supplies and materials” in the figure (-49% YTY in August 2009). The decline in consumer goods imports (-17% YTY in August 2009) is much less and the decline in the growth of services imports (-15% YTY in August 2009) even less than for goods. Throughout the downturn, services trade, especially of business services, has been relatively unaffected (see Borchert and Mattoo, 2009). Borchert and Mattoo (2009) list a number of reasons why the demand for services has contracted less than the demand for goods in the recent crisis, including the non-storability of services and the fact that a larger part of services demand involves outsourced services (e.g. book-keeping) which are “necessities” for producers.

7 WTO (2010). 8 Baldwin (2009).

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