Working Paper: CEPR ID: DP18558
Authors: Giancarlo Corsetti; Lucio Daguanno; Aydan Dogan; Simon Lloyd; Rana Sajedi
Abstract: Unlike final-goods trade, intermediate-input trade through Global Value Chains (GVCs) creates supply-side linkages across borders. We show that, even when GVCs themselves are efficient, they have welfare implications because these linkages affect countries’ ability to share risks in incomplete financial markets. This novel interaction between trade and finance arises from a distinct channel of cross-border transmission with GVCs, the marginal-cost effect. Productivity shocks, by moving relative prices, impact the marginal cost of production both at home and abroad, and therefore, in equilibrium, their relative supply. When international financial markets are incomplete, these supply-side linkages will affect household wealth in both countries, and, in turn, the degree of international risk sharing. The direction and strength of this effect varies with the trade elasticity and the degree of GVC integration, with non-monotonic effects leading to ‘fragmentation traps’ in which small increases in GVC integration reduce risk sharing, while large increases would improve it. We show that in the quantitatively relevant case, GVCs reduce cross-border misalignments, and so endogenously support international risk sharing.
Keywords: cross-border transmission; incomplete asset markets; intermediate goods trade; global financial markets; supply chain linkages
JEL Codes: F32; F33; F41; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| GVC integration (F12) | international risk sharing (F30) |
| international risk sharing (F30) | welfare (I38) |
| productivity shocks (O49) | relative prices (P22) |
| relative prices (P22) | marginal cost of production (D24) |
| marginal cost of production (D24) | international risk sharing (F30) |
| GVC integration (F12) | household wealth (D14) |
| household wealth (D14) | international risk sharing (F30) |
| GVC integration (F12) | cross-border misalignments (F55) |
| cross-border misalignments (F55) | international risk sharing (F30) |