Friday 31 March 2017

About 95 percent of the world’s population lives outside the united State, but many U.S. companies, especially small businesses, still do not...

Most companies around the world are not involved in international trade.

There are two basic reasons for this; one is rational, the other less so.

The rational reason is trade costs. It can be expensive to set up the sort of logistics and distribution networks that are necessary to get involved in world trade. Particularly for very small businesses, these costs could be prohibitive. In fact, many very small businesses only work with customers over a very narrow geographical area (such as within the same city, or even the same neighborhood) because expanding beyond that is so costly.

The less-rational reason is home bias. There is a well-documented bias in trade patterns around the world, which has been called the home bias in trade puzzle. Most countries only trade a small portion of their economy, and trade most with countries that are nearby and very similar to them. With modern distribution networks, it's implausible that trade costs are actually that high, especially for large corporations; and worse, comparative advantage should be largest with countries that are more different, not countries that are more similar.

Behavioral economics gives us some insight into this problem. The best evidence we have so far suggests that people basically identify more with those who are more similar to them, as well as those whom they have more contact with---for example Americans identify most of all with Americans, and to a lesser extent with Canadians and Europeans, and much less so with people in China or India. People are more comfortable trading with people they identify with, and are more willing to trust them (and remember, almost all transactions require some degree of trust). As a result, most trade happens between countries that are very similar to each other, because those are the countries people feel most comfortable trading with. Even if there would be economic advantages to trading with unfamiliar countries, people are simply less willing to try it.

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