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Information Frictions and the Law of One Price: “When the States and the Kingdom became United”

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  • Claudia Steinwender

Abstract

How do information frictions distort international trade? This paper exploits a unique historical experiment to estimate the magnitude of these distortions: the establishment of the transatlantic telegraph connection in 1866. I use a newly collected data set based on historical newspaper records that provides daily data on information flows across the Atlantic together with detailed, daily information on prices and trade flows of cotton. Information frictions result in large and volatile deviations from the Law of One Price. What is more, the elimination of information frictions has real effects: Exports respond to information about foreign demand shocks. Average trade flows increase after the telegraph and become more volatile, providing a more efficient response to demand shocks. I build a model of international trade that can explain the empirical evidence. In the model, exporters use the latest news about a foreign market to forecast expected selling prices when their exports arrive at the destination. Their forecast error is smaller and less volatile the more recent the available information. I estimate the welfare gains from information transmission through the telegraph to be roughly equivalent to those from abolishing a 6% ad valorem tariff.

Suggested Citation

  • Claudia Steinwender, 2014. "Information Frictions and the Law of One Price: “When the States and the Kingdom became United”," Working Papers 190, Oesterreichische Nationalbank (Austrian Central Bank).
    • Handle: RePEc:onb:oenbwp:190
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    Cited by:

    1. Michel Fouquin & Jules Hugot, 2016. "Back to the Future: International Trade Costs and the Two Globalizations," Vniversitas Económica 15130, Universidad Javeriana - Bogotá.
    2. Cassehgari Posada, Kian & Ganne, Emmanuelle & Piermartini, Roberta, 2020. "The role of WTO committees through the lens of specific trade concerns raised in the TBT committee," WTO Staff Working Papers ERSD-2020-09, World Trade Organization (WTO), Economic Research and Statistics Division.
    3. Konrad B Burchardi & Thomas Chaney & Tarek A Hassan, 2019. "Migrants, Ancestors, and Foreign Investments," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 86(4), pages 1448-1486.
    4. Fabio Santeramo, 2015. "A cursory review of the identification strategies," Agricultural and Food Economics, Springer;Italian Society of Agricultural Economics (SIDEA), vol. 3(1), pages 1-8, December.
    5. Wolfgang Keller & Carol H. Shiue, 2013. "The Link Between Fundamentals and Proximate Factors in Development," NBER Working Papers 18808, National Bureau of Economic Research, Inc.
    6. Sam Haltenhof, "undated". "Services Trade and Internet Connectivity," Working Papers 668, Research Seminar in International Economics, University of Michigan.
    7. Clemence Lenoir & Isabelle Mejean & Julien Martin, 2018. "Search Frictions in International Good Markets," 2018 Meeting Papers 878, Society for Economic Dynamics.
    8. Isaac Baley & Laura Veldkamp & Michael Waugh, 2016. "Information globalization," Economics Working Papers 1529, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 2019.
    9. Baley, Isaac & Veldkamp, Laura & Waugh, Michael, 2020. "Can global uncertainty promote international trade?," Journal of International Economics, Elsevier, vol. 126(C).
    10. Wolfgang Keller & Carol H. Shiue, 2016. "Market Integration as a Mechanism of Growth," CESifo Working Paper Series 6070, CESifo.
    11. Wolfgang Keller & Carol H. Shiue, 2020. "Market integration and institutional change," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 156(2), pages 251-285, May.
    12. repec:hal:spmain:info:hdl:2441/4j5snkuat19kma9diah5p0g5eq is not listed on IDEAS
    13. Kunal Dasgupta & Jordi Mondria, 2015. "Gains from Trade under Quality Uncertainty," Working Papers tecipa-526, University of Toronto, Department of Economics.
    14. Dasgupta, Kunal & Mondria, Jordi, 2018. "Inattentive importers," Journal of International Economics, Elsevier, vol. 112(C), pages 150-165.

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