Tyler Cowen: evaluation

Transcript context

…I would say there’s a few things. One is there is the short term. There is the near term when the invoicing currency matters, but just the example I just gave you tells you why people have chosen to invoice in one currency versus another. The way you think about it is that, ideally, if you could flexibly adjust your price at every instant in time, then obviously invoicing currency is irrelevant, but companies do sign longer-term contracts. One of the things I looked into when I was doing the research on this was to say, “If companies are signing long-term contracts, is this both about prices and about quantities?” It’s not just that I sign a contract that says I’m going to sell to you at this per-unit price, but it’s also that I’m only going to sell X amount of quantity, in which case then these prices are not allocative. If you look at the contracts, that’s actually not the case. The way it works is that the companies say, “We’ll sell it to you at this price. The quantities, we have a range. Obviously, it’s not like we can send you any amount. There is a range of quantities at which we will send to you,” so there’s that much more flexibility. There is the short term, and then there is the medium term. I think what’s important to recognize is that the invoicing decision itself is not just some Calvo fairy. It’s not just some “Here, we’re going to assume that we wake up and somebody’s told me to price in dollars.” There is a reason why the dollar is used as a pricing currency around the world. From a pure first principle, it’s not a decision about which currency to invoice. There’s evidence consistent with that. Now, as you know, the gravity equation is one of the most reliable regularities in international trade economics. Basically, the quantity of trade is inversely proportional to the distance of countries once you adjust for incomes and some other matters. That seems to be another case where the relative price doesn’t matter that much because few people think the gravity equation is about transportation costs. Why is it, in your view, that the gravity equation holds so reliably and so consistently? Again, I’m not an expert on the gravity equation, but what we do see is it is the case that physical distance does matter. There’s a reason why trade between the US and Mexico and Canada should be as close as it should be, setting aside the tariffs that are happening right now. There’s a reason why it makes a lot of sense for countries that are physically closer that this should be the case. Distance does matter. Over time, obviously, once you build up these networks and you’ve built up these relationships, they can persist over time. You can, of course, build pipelines and you can build other kinds of logistical networks to get goods around, but distance does matter. We also do know that the relative incomes of the countries do matter too. There’s more trade happening between the countries that are large, and that also plays a role.…

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