Indirect Energy Costs and Comparative Advantage

We investigate whether the costs of an input to production embodied in the supply chain can be a source of comparative advantage. Motivated by the fact that most industrial energy use takes place in the supply chain, we focus on the case of energy costs. Using a disaggregated dataset on trade flows in manufacturing industries around the world, we find that both direct and indirect energy costs passed on through intermediate goods have a significant effect on the pattern of international trade. We also show that industries in countries with high energy prices attempt to mitigate these effects by importing energy-intensive, intermediate goods from countries that have lower energy prices. We consider the economic significance of our results by calculating the effects of the energy price increases that occurred in the European Union in the mid-2000s onwards. We find that EU manufacturing exports decline anywhere from 6.8 percent to 15 percent, depending on the elasticity of input substitution. Our results demonstrate that there is a substantial difference in the estimated effect of energy prices on international trade when indirect energy costs are taken into account.