Can Global Uncertainty Promote International Trade?

Authors: Isaac Baley, Laura Veldkamp and Michael Waugh

Journal of International Economics, Vol. 126, September, 2020

Common wisdom holds that uncertainty impedes trade—yet we show that uncertainty can fuel more trade in a simple general equilibrium trade model with information frictions. In equilibrium, increases in uncertainty increase both the mean and variance in returns to exporting. This implies that trade can increase or decrease with uncertainty, depending on preferences. Under general conditions on preferences, we characterize the importance of these forces using a sufficient statistics approach. Higher uncertainty leads to increases in trade because agents receive improved terms of trade, particularly in states of nature in which consumption is most valuable. Trade creates value, in part, by offering a mechanism for risk sharing, and risk sharing is most effective when both parties are uninformed.

This paper originally appeared as Barcelona GSE Working Paper 917