P. Pogany - The Global Income Elasticity of Trade: Theory and Potential Applications

Global income elasticity of trade (GIET) is the percentage increase in world imports or exports, attributable to a percentage increase in world income or output. Theoretical and econometric research has shown that greater ~than unitary income elasticities to import and to export have characterized the trade of the industrialized countries since World War Il. Given the overwhelming weight of the industrialized countries in world trade, this fact alone is sufficient to assert that greater than unitary GIET (that is, nonhomotheticity) prevailed in the postwar era. Nonetheless, for reasons of algebraic convenience and simplicity contemporary dynamic models lean heavily on the use of unitary national income elasticities of trade. By attributing homothetic preferences to all national and regional consumption, models inadvertently assign unity to the GIET, breeding errors in trade policy simulation models and depriving them of analytical opportunities. The analysis of global income elasticity must deal with two kinds of income effects, general and particular. The effect exerted on the volume of trade by rising levels of world income is the general income effect. The income effect that may be traced back to changes in the price ratios is the particular income effect. Accordingly, the GIET that captures both types of income effects may be called the gross GIET. The one that captures only the general income effects may be called the net GIET. For 1965-93, the net GIET was found to be at least 1.50, and was labeled very strong. When the net GIET exceeds 1, the use of the homothetic assumption in models devised to measure the consequences of trade policy alternatives leads to an understatement of the economic growth and welfare benefits of trade liberalization. Such understatements are evident in calculations regarding the benefits of the Tokyo Round and the Uruguay Round. JEL Classification: .