Trading with Friends in Uncertain Times

IMF Working Papers, June 16, 2023

Source details

Research question: How are patterns of bilateral trade altered by rising trade policy uncertainty (TPU), and do geopolitical alignments between country pairs determine how bilateral trade flows react during periods of greater uncertainty?
Core finding: Using a structural gravity framework augmented with a text-based TPU index and a geopolitical distance measure based on UN General Assembly voting records, the authors find a significant negative effect of geopolitical distance when TPU is elevated, indicating a shift to trading among “friends” in uncertain times.

Framework: Structural gravity model of bilateral trade.
TPU measure: Text-based TPU index.
Geopolitical alignment measure: Geopolitical distance based on UN General Assembly voting records.
Fixed effects: Importer-exporter FE are employed (noted among Keywords).

Geopolitical distance interacts negatively with elevated TPU: higher TPU amplifies a negative effect of geopolitical distance on bilateral trade.
Interpretation: During periods of greater TPU, trade shifts toward closer geopolitical partners (“friends”).

Trade resilience considerations: Geopolitical alignments matter for trade flows under uncertainty; policies aimed at diversification should account for geopolitical proximity effects.
Trade policy design: Monitoring TPU and geopolitical alignments can inform trade policy responses to uncertainty and trade tensions.