Information Globalization, Risk Sharing, and International Trade

Information frictions are often invoked to explain low levels of international trade beyond those that measured trade frictions (tariffs, transportation costs, etc.) can explain. But to explain why international trade is lower then domestic trade, home firms have to know something that foreigners do not. Without information asymmetry, domestic trade and foreign trade would be inhibited equally. This paper incorporates a simple information asymmetry in a standard, two-country Armington trade model and studies its effect on international risk sharing and trade flows. We find that ameliorating information asymmetry – information globalization – reduces trade and international risk sharing. In other words, asymmetric information frictions behave in the opposite manner as a standard trade cost. Many researchers have explored the possibility that information frictions account for the low volumes of crossborder trade. ? show that the volume of phone calls between two countries predicts how much they trade. ? and ? argue that immigrants trade more with their home countries. The argument that information frictions create uncertainty about foreign economies, and that this uncertainty deters risk-averse potential exporters is compelling. In many settings, the effect of an increase in uncertainty is to reduce the certainty-equivalent expected return, which acts like a tax on transactions. But to explain why firms trade less across borders than within borders, it is essential to consider not just imperfect information, but asymmetric information. If an information friction inhibits foreign, but not domestic trade, then domestic firms must know something about each other that foreign firms do not know. We take the most standard, simple trade model – a two-good, two-country Armington model – and add information asymmetry in the most obvious way: Each country experiences a random endowment shock that its home firms observe perfectly, but foreigners observe imperfectly, with a noisy signal. Each firm chooses what fraction of their endowment to export to an international market. The international relative price clears that market, goods are immediately shipped to their destination country, and agents consume. Although the argument that a lack of information deters trade is ∗Department of Economics and Business, Universitat Pompeu Fabra, Ramon Tŕıas Fargas 25-27, Barcelona, Spain 08005; [email protected]; https://sites.google.com/a/nyu.edu/isaacbaley/. †Department of Economics, Stern School of Business, New York University, NBER and CEPR, 44 W. 4th Street, New York, NY 10012; [email protected]; http://www.stern.nyu.edu/∼lveldkam. ‡Department of Economics Stern School of Business, New York University and NBER, 44 W. 4th Street, New York, NY 10012; [email protected]; https://files.nyu.edu/mw134/public/index.html. We thank David Backus, Xavier Gabaix, Matteo Maggiori, Thomas Sargent, Stanley Zin, our discussants Alexander Monge-Naranjo, Jaromir Nosal, Kunal Dasgupta, and seminar participants at NYU, SED 2014 Meetings, EconCon 2014, Philadelphia FED, Atlanta FED, Maryland, ASSA 2015 Meetings, Princeton, and NYU Stern School of Business. Callum Jones and Pau Roldán provided excellent research assistance.