For release: Nov. 03, 2004

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Trade with Nearby Countries on the Rise: St. Louis Fed Analysis

St. Louis.— Despite advances in technology that have made communicating throughout the world easier, an analysis by the Federal Reserve Bank of St. Louis indicates that exports from U.S. states are increasing more rapidly with nearby countries than those farther away.

That analysis comes from Cletus C. Coughlin, deputy director of research at the St. Louis Fed, writing in the November/December issue of Review, the Reserve Bank’s bimonthly journal of economic and business topics. The publication is also available on the Reserve Bank’s web site.

Distance has been thought to play a key role in the geographic distribution of trade for several reasons. For longer distances, transportation costs and the costs of accessing information about foreign markets and establishing a trade relationship in those markets are higher.

“Despite the ‘death of distance’ associated with the communications revolution, proximity appears to be increasingly important for trade flows,” said Coughlin.

Coughlin found that the geographic distribution of state exports has become more intense with nearby countries relative to more distant countries, although all states did not experience the same changes. Measured by the distance of trade—the average distance that a state’s international trade is transported—40 states experienced a declining distance of trade, while 11 states experienced an increasing distance of trade.

For example, his analysis covering 1988-92 and 1998-2002 clearly shows that Canada, Mexico, and Latin America and the Caribbean are the destinations for increasing shares of U.S. exports, while the share of U.S. exports to Europe, Asia, Africa and Oceania are decreasing.

Coughlin noted that during the second half of the 20th century, the volume of international trade throughout the world increased more rapidly than output. He cited one study which shows that the decline in transportation costs accounted for 8 percent of the average trade growth of several developed countries, tariff-rate reductions about 25 percent, and income growth the remaining 67 percent.

Consequently, Coughlin looked at the “usual suspects” of international trade to determine why trading partners are doing more business with those nearby than farther away. Those elements are:

• Changing transportation costs. The relationship between transportation costs and the distance of trade is unclear. For example, declining transportation costs may be associated with either an increasing or decreasing distance of trade. In the context of
  U.S. trade, it is likely that declining costs of transportation over land have tended to encourage state exports to Canada and Mexico relative to exports to more distant locations.

• Regional trade agreements. A well-known finding is that the impact of regional trade agreements, such as NAFTA, tends to change the geographic trade pattern toward larger shares of trade with nearby trading partners vs. those that are more distant. In his study, Coughlin found that states experiencing larger export effects due to NAFTA had larger declines in their distance of trade.

• Uneven income growth. Other things the same, if a country’s nearby trading partners have greater income growth relative to its more distant trading partners, the country’s distance of trade with its nearby partners will increase relative to trading with those farther away. Coughlin found states whose nearby trading partners grew more rapidly had larger declines in their distance of trade.

“These results,” Coughlin concluded, “suggest that the factors cited in the analysis—declining transportation costs over land, the implementation of NAFTA, and faster income growth by nearby trading partners relative to distant trading partners—have contributed to this changing geography of exports for the United States.”

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve Banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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