Comments on Comments on ““Income and Price Elasticities of Income and Price Elasticities of Croatian TradeCroatian Trade - A Panel Data - A Panel Data

ApproachApproach””Bobić VidaBobić Vida

by by Saša ŽikovićSaša Žiković

MotivationMotivation

Croatia’s current account deficit is for the most part a consequence of a large deficit in merchandise trade.

The goal of the paper was to determine the most important factors which affect movements in Croatian merchandise trade.

Stable elasticity coefficients can be of great use in 1) gauging the impact of changes in the economy as well as of fiscal and monetary policy measures on the trade balance and 2) macroeconomic forecasting.

Analyse the influence of kuna/euro exchange rate on trade and competitiveness of Croatian goods.

DataData Period: 2000-2007 annual data

Variables: Sectoral imports and exports according to the

National Classification of Economic Activities (NCEA) – 30 sectors

Income (world total real GDP, Croatian real GDP) Prices (unit value indices calculated from

disaggregated data on euro values and quantities) Nominal kuna/euro exchange rate FDI (stock or flow?) Croatian import tariffs

Model: dynamic panel data method – estimation via GMM

FindingsFindings

Export function: Import function:Export function: Import function:

Import tariffs expected sign but negligible effect For Croatian exports, competitiveness works through

prices, not quality of goods. Exchange rate does not have a strong role in

determining export flows, while it contributes to import growth.

Use of currency depreciation as an export promotion tool is not validated.

Good points of the paperGood points of the paper

First, the paper asks a very interesting and First, the paper asks a very interesting and relevant research question, which is of great relevant research question, which is of great importance for the Croatian policy makers.importance for the Croatian policy makers.

Second, this paper is among a few papers that Second, this paper is among a few papers that empirically deals with trade mechanics in Croatia.empirically deals with trade mechanics in Croatia.

The finding from this paper (if accepted as valid) The finding from this paper (if accepted as valid) raise important economic and political questions raise important economic and political questions in Croatia (other transitional countries?).in Croatia (other transitional countries?).

The author shows good understanding of issues The author shows good understanding of issues involved in trade modellinginvolved in trade modelling

Overall, this is a well-written, interesting paper Overall, this is a well-written, interesting paper with a potential to be with a potential to be a a publishable piece of work.publishable piece of work.

CommentsComments and and questions questions

The purpose of the paper has very little ambition (income The purpose of the paper has very little ambition (income and price elasticities) or is it to ambitious (HRK/€)?and price elasticities) or is it to ambitious (HRK/€)?

What does this paper bring new to the literature about What does this paper bring new to the literature about transitional economies?transitional economies?

Who will be interested in this paper?Who will be interested in this paper? What are the policy implications?What are the policy implications? What should be done on fiWhat should be done on fisscal and monetary front?cal and monetary front? There is no explanation of Croatian economical and trade There is no explanation of Croatian economical and trade

specifics. An investigation of these would substantially specifics. An investigation of these would substantially increase the quality of the paper!increase the quality of the paper!

Taking account of regional elements and previous Taking account of regional elements and previous knowledge of product and trade among ex YU and ex knowledge of product and trade among ex YU and ex communists countries is necessary.communists countries is necessary.

What happened in 2003-2004 (reversal of trend)?What happened in 2003-2004 (reversal of trend)? Page 3 – Page 3 – What is the reason of Croatia’s low

competitiveness and pronounced imbalance in international trade?

This is a solid econometric exercise but...This is a solid econometric exercise but...

Although the author is aware of Croatian specifics the Although the author is aware of Croatian specifics the paper still uses the most standard setup, why? paper still uses the most standard setup, why? (potential to be the first and original)!(potential to be the first and original)!

For some strong presumptions there is little backing For some strong presumptions there is little backing in the literaturein the literature

Better literature overview – what are the findings of Better literature overview – what are the findings of the papers that are mentioned in the overview (some the papers that are mentioned in the overview (some of them are contradicting the findings in this paper)of them are contradicting the findings in this paper)

Wide range of elasticity coefficient 0.17-5.3 why are Wide range of elasticity coefficient 0.17-5.3 why are they not presented?they not presented?

Are the coefficients stable? Robustness check?Are the coefficients stable? Robustness check?➨ Given the nonstationarity of variables, cointegration Given the nonstationarity of variables, cointegration

analysis seems an appropriate technique for analysis seems an appropriate technique for uncovering the existence of a long-run relationship uncovering the existence of a long-run relationship involving the export price, domestic cost, and the involving the export price, domestic cost, and the exchange rate!exchange rate!

CommentsComments and and questions questions

CommentsComments and and questions questions What about regional prices (a lot of empirical proofs What about regional prices (a lot of empirical proofs

about competition among transitional countries (TC) for about competition among transitional countries (TC) for the placement of goods in developed countries - see the placement of goods in developed countries - see Faini, Clavijo, Senhadji-Semlali (1992) )Faini, Clavijo, Senhadji-Semlali (1992) )

As a result of these factors, exchange rate policies lose As a result of these factors, exchange rate policies lose much of their effectiveness, demand from developed much of their effectiveness, demand from developed countries is again a major determinant of TC export countries is again a major determinant of TC export performance. performance.

Devaluation is an effective tool in this respect when used Devaluation is an effective tool in this respect when used by one TC, if employed by a group the effects are wiped by one TC, if employed by a group the effects are wiped out!out!

Devaluation though may still be an effective tool to Devaluation though may still be an effective tool to promote efficient import substitution, bring a more promote efficient import substitution, bring a more efficient allocation of resources and by avoiding efficient allocation of resources and by avoiding unrealistic appreciation, deter capital flights from the unrealistic appreciation, deter capital flights from the onset. onset.

Importance of regional effects!Importance of regional effects!

CommentsComments and and questions questions

The paper should take into account that placing The paper should take into account that placing Croatian goods on foreign markets were caused Croatian goods on foreign markets were caused mainly by (1) a breakdown of the ex YU and mainly by (1) a breakdown of the ex YU and communist markets, which had absorbed the bulk of communist markets, which had absorbed the bulk of Croatian exports prior to 1991; (2) the still low Croatian exports prior to 1991; (2) the still low competitiveness of Croatian production; (3) changing competitiveness of Croatian production; (3) changing ownership relations in firms and unfinished company ownership relations in firms and unfinished company restructuring (4) warrestructuring (4) war

Are there any structural breaks in the data?Are there any structural breaks in the data?

What structural equations What structural equations areare used in the used in the paper?paper?

The imperfect substitutes model (Goldstein, Moris, The imperfect substitutes model (Goldstein, Moris, Khan 1985)? OR some extension?Khan 1985)? OR some extension?

Other models: Greenhalgh, Taylor and Wilson (1994), Other models: Greenhalgh, Taylor and Wilson (1994), Blake and Pain (1994), Pain and Wakelin (1997), Blake and Pain (1994), Pain and Wakelin (1997), Greenaway, Souza and Wakelin (2002), Algieri Greenaway, Souza and Wakelin (2002), Algieri (2004)...?(2004)...?

CommentsComments and and questions questions

TTraditional imperfect substitutes modelraditional imperfect substitutes model:: domestic cost and domestic cost and foreign prices are treated as exogenous to exchange rate foreign prices are treated as exogenous to exchange rate changes. changes.

Such an assumption may be justified for some group of Such an assumption may be justified for some group of products and possibly in the short run. products and possibly in the short run.

ThisThis seems inappropriate given the pervasive effects of seems inappropriate given the pervasive effects of exchange rates on production costs through imported inputs exchange rates on production costs through imported inputs and indirect cost competition in the world market. and indirect cost competition in the world market.

For instance, the prices of commodities are usually For instance, the prices of commodities are usually denominated and invoiced in dollars. Thus, a depreciation of denominated and invoiced in dollars. Thus, a depreciation of the currency vis-a-vis the dollar will increase the non-US dollar the currency vis-a-vis the dollar will increase the non-US dollar prices of commodities, which in turn will raise production costs prices of commodities, which in turn will raise production costs and export prices. and export prices.

IIn traditional trade models, a currency depreciation n traditional trade models, a currency depreciation deteriorates the terms of trade, which tends to increase the deteriorates the terms of trade, which tends to increase the trade balance and aggregate demand. Unless the returns to trade balance and aggregate demand. Unless the returns to scale are constant, unit costs are likely to vary with changes in scale are constant, unit costs are likely to vary with changes in aggregate demand. aggregate demand.

CommentsComments and and questions questions FDI variable:FDI variable: The paper uses the logic behind the use of FDI as a The paper uses the logic behind the use of FDI as a

proxy for competitiveness and productivity (taken proxy for competitiveness and productivity (taken from Czech Rep.) – from Czech Rep.) – not appropriatenot appropriate since in CZE it since in CZE it went into manufacturing industry in CRO mostly went into manufacturing industry in CRO mostly service sector without export potential!service sector without export potential!

Prices variablePrices variable:: “ “...relatively more expensive imports which will work ...relatively more expensive imports which will work

to lower imported quantities” not so straightforward, to lower imported quantities” not so straightforward, what about product like (cars, phones, computers, what about product like (cars, phones, computers, building machinery...)?building machinery...)?

Bias in obtained results due to both homogenous and Bias in obtained results due to both homogenous and differentiated goods within sectors – solution: use differentiated goods within sectors – solution: use indexes of product differentiation - see Chiarlone indexes of product differentiation - see Chiarlone (2000) (2000)

Focus on main trading partners not the whole worldFocus on main trading partners not the whole world

CommentsComments and and questions questions

Income variableIncome variable:: World total GDP – main trading partners GDP?World total GDP – main trading partners GDP?

Tariffs variableTariffs variable:: Tariffs in foreign markets, EU quotas, non tariff Tariffs in foreign markets, EU quotas, non tariff

impediments to exports from Croatia – significant impediments to exports from Croatia – significant but not taken into accountbut not taken into account

By concentrating on main trading partners import By concentrating on main trading partners import tariffs could be accounted for (not an easy but a tariffs could be accounted for (not an easy but a extremely important task!)extremely important task!)

What about the other side of the coin – subsidies, What about the other side of the coin – subsidies, completely unchecked (why?)completely unchecked (why?)

See the cuSee the currrent cheese crisis imported from EU!rent cheese crisis imported from EU!

CommentsComments and and questions questions Exchange rate variableExchange rate variable:: Check the real effective exchange rate index based on the CPI Check the real effective exchange rate index based on the CPI

and related to the currencies of the given trade partnersand related to the currencies of the given trade partners During the investigated period kuna is appreciating against the During the investigated period kuna is appreciating against the

euro, there is no strong depreciation so how can any conclusion euro, there is no strong depreciation so how can any conclusion be drawn about the effects of kuna depreciation?be drawn about the effects of kuna depreciation?

Exchange rate also works through price variable, how can the Exchange rate also works through price variable, how can the paper say that exchange rate depreciation is unimportant in paper say that exchange rate depreciation is unimportant in exports?exports?

Wansing Hung et al. (1993) found feedback into the exchange Wansing Hung et al. (1993) found feedback into the exchange rate from the other variables is prerate from the other variables is pressent in most countries. The ent in most countries. The feedback tends to make the exchange rate innovations decay feedback tends to make the exchange rate innovations decay rapidly.rapidly.

In estimation, a simultaneous equations approach seems In estimation, a simultaneous equations approach seems necessary to properly estimate pass-through processes since necessary to properly estimate pass-through processes since exogeneity assumptions are clearly violated in most countries.exogeneity assumptions are clearly violated in most countries.

Be careful this is a overly simplifed analysis to conclude anything Be careful this is a overly simplifed analysis to conclude anything about exchange rate mechanics!about exchange rate mechanics!

CommentsComments and and questions questionsSome of the variables that are omitted but should be checked:Some of the variables that are omitted but should be checked: monetary policy interest ratemonetary policy interest rate economies of scale economies of scale supply-side based factor shaping the intensity of exports and supply-side based factor shaping the intensity of exports and

imports is economies of scale – see Krugman and Obstfeld imports is economies of scale – see Krugman and Obstfeld (2003) - approximated by material inputs.(2003) - approximated by material inputs.

change in productivitychange in productivity Capital (at constant prices) per unit of labour - reallocation of Capital (at constant prices) per unit of labour - reallocation of

production to industries that use higher capital per labour production to industries that use higher capital per labour leads to an increase in exports!leads to an increase in exports!

Tariff rates levied abroad on Croatian exportsTariff rates levied abroad on Croatian exports Monetary policy (stock of real M2)Monetary policy (stock of real M2) Material input values adjusted for price changesMaterial input values adjusted for price changes Croatian price changes in industries - measuring the intensity Croatian price changes in industries - measuring the intensity

of nominal convergenceof nominal convergence indexes of quality and supply reliability - Greenhalgh, Taylor indexes of quality and supply reliability - Greenhalgh, Taylor

and Wilson (1994)and Wilson (1994) Availability of output as a determinant of exports (Algieri, Availability of output as a determinant of exports (Algieri,

2004)2004)

CommentsComments and and questions questions

A lot ofA lot of studies emphasize the importance of studies emphasize the importance of market structure - the market share, market market structure - the market share, market concentration, substitutability between domestic concentration, substitutability between domestic and foreign variants of a product, high sunk cost and foreign variants of a product, high sunk cost of production, the level of trade barriers, etc. of production, the level of trade barriers, etc.

See Dornbusch (1987), Baldwin (1988), Dixit See Dornbusch (1987), Baldwin (1988), Dixit (1989), Froot and Klemperer (1989), and Feenstra (1989), Froot and Klemperer (1989), and Feenstra (1989). (1989).

These effects are expected to be more important These effects are expected to be more important in less than perfectly competitive market (exporter in less than perfectly competitive market (exporter follows the competitors’ price) such as Croatia.follows the competitors’ price) such as Croatia.

Where is outWhere is out--ofof--thethe--sample forecasting to validate sample forecasting to validate thethe findings? findings?

CommentsComments and and questions questions

What is the export content of imports?What is the export content of imports? Is there any correlation between exports and Is there any correlation between exports and

imports within the same sectors (intra-industry imports within the same sectors (intra-industry trade)?trade)?

As the negative sign of As the negative sign of import prices import prices reveals, the reveals, the import penetration strategies of exporters are based import penetration strategies of exporters are based on competition in product price not quality – this is on competition in product price not quality – this is strange (opposite is found for other transitional strange (opposite is found for other transitional economieseconomies)) – what is the meaning of this? – what is the meaning of this?

How does Croatian production compete with How does Croatian production compete with imports? Test this by testing Croatian price changes imports? Test this by testing Croatian price changes in industries in the import equation. If it has a in industries in the import equation. If it has a positive coefficient it means that a domestic price positive coefficient it means that a domestic price increase supports imports increase supports imports

ConclusionConclusion

Foundations have been laid but a lot of Foundations have been laid but a lot of work and sleepless nights still ahead!work and sleepless nights still ahead!

Congratulation to the author on having the Congratulation to the author on having the courage to chose a very courage to chose a very demandingdemanding but but importantimportant field of research for any country field of research for any country in the world.in the world.

If the author wishes to pursue this field of If the author wishes to pursue this field of research I wish her the best of luck!research I wish her the best of luck!