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Information frictions and the law of one price: "When the States and the Kingdom became United"

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  • Steinwender, Claudia

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

  • Steinwender, Claudia, 2014. "Information frictions and the law of one price: "When the States and the Kingdom became United"," WTO Staff Working Papers ERSD-2014-12, World Trade Organization (WTO), Economic Research and Statistics Division.
    • Handle: RePEc:zbw:wtowps:ersd201412
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    Cited by:

    1. Gino Gancia, 2014. "Globalization and Political Structure," 2014 Meeting Papers 644, Society for Economic Dynamics.
    2. Réka Juhász & Claudia Steinwender, 2018. "Spinning the Web: The Impact of ICT on Trade in Intermediates and Technology Diffusion," NBER Working Papers 24590, National Bureau of Economic Research, Inc.
    3. Gábor Békés & Lionel Fontagné & Balázs Muraközy & Vincent Vicard, 2017. "Shipment frequency of exporters and demand uncertainty," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 153(4), pages 779-807, November.
    4. Maggie X. Chen & Min Wu, 2016. "The Value of Reputation in Trade: Evidence from Alibaba," Working Papers 2016-20, The George Washington University, Institute for International Economic Policy.
    5. Christopher Parsons & Pierre‐Louis Vézina, 2018. "Migrant Networks and Trade: The Vietnamese Boat People as a Natural Experiment," Economic Journal, Royal Economic Society, vol. 128(612), pages 210-234, July.
    6. Gabor Békés & Lionel Fontagné & Balazs Murakozy & Vincent Vicard, 2015. "Shipment frequency of exporters and demand uncertainty: An inventory management approach," Working Papers hal-01315615, HAL.
    7. 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.
    8. Konrad B Burchardi & Thomas Chaney & Tarek A Hassan, 2019. "Migrants, Ancestors, and Foreign Investments," Review of Economic Studies, Oxford University Press, vol. 86(4), pages 1448-1486.
    9. Wilson, Chris M., 2016. "Information Matters: A Theoretical Comparison of Some Cross-Border Trade Barriers," EconStor Preprints 130180, ZBW - Leibniz Information Centre for Economics.
    10. Baley, Isaac & Veldkamp, Laura & Waugh, Michael, 2020. "Can global uncertainty promote international trade?," Journal of International Economics, Elsevier, vol. 126(C).
    11. Gabor Békés & Lionel Gérard Fontagné & Balazs Murakozy & Vincent Vicard, 2014. "Shipment Frequency of Exporters and Demand Uncertainty," CESifo Working Paper Series 4734, CESifo.
    12. 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.
    13. Isaac Baley & Laura Veldkamp & Michael Waugh, 2016. "Information globalization," Economics Working Papers 1529, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 2019.
    14. Clemence Lenoir & Isabelle Mejean & Julien Martin, 2018. "Search Frictions in International Good Markets," 2018 Meeting Papers 878, Society for Economic Dynamics.
    15. Dasgupta, Kunal & Mondria, Jordi, 2018. "Inattentive importers," Journal of International Economics, Elsevier, vol. 112(C), pages 150-165.
    16. Wolfgang Keller & Carol H. Shiue, 2016. "Market Integration as a Mechanism of Growth," CESifo Working Paper Series 6070, CESifo.
    17. Keller, Wolfgang & Shiue, Carol H, 2016. "Market Integration as a Mechanism of Growth," CEPR Discussion Papers 11627, C.E.P.R. Discussion Papers.
    18. Porteous, Obie C., 2015. "High Trade Costs and Their Consequences: An Estimated Model of African Agricultural Storage and Trade," 2015 AAEA & WAEA Joint Annual Meeting, July 26-28, San Francisco, California 205776, Agricultural and Applied Economics Association.
    19. Michel Fouquin & Jules Hugot, 2016. "Back to the Future: International Trade Costs and the Two Globalizations," Vniversitas Económica 015130, Universidad Javeriana - Bogotá.
    20. Kunal Dasgupta & Jordi Mondria, 2015. "Gains from Trade under Quality Uncertainty," Working Papers tecipa-526, University of Toronto, Department of Economics.
    21. Sam Haltenhof, "undated". "Services Trade and Internet Connectivity," Working Papers 668, Research Seminar in International Economics, University of Michigan.
    22. Anais Maillet, 2015. "Food price volatility and farmers' production decisions under imperfect information," FOODSECURE Technical papers 8, LEI Wageningen UR.

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