by Saša Žiković

1. Comments on “Income and Price Elasticities of Croatian Trade- A Panel Data Approach”Bobić Vida by Saša Žiković

2. Motivation • Croatia’s current account deficit is for the most part a consequence of a large deficit in merchandise trade. • The goal of the paper was to determine the most important factors which affect movements in Croatian merchandise trade. • Stable elasticity coefficients can be of great use in 1) gauging the impact of changes in the economy as well as of fiscal and monetary policy measures on the trade balance and 2) macroeconomic forecasting. • Analyse the influence of kuna/euro exchange rate on trade and competitiveness of Croatian goods.

3. Data • Period: 2000-2007 annual data • Variables: • Sectoral imports and exports according to the National Classification of Economic Activities (NCEA) – 30 sectors • Income (world total real GDP, Croatian real GDP) • Prices (unit value indices calculated from disaggregated data on euro values and quantities) • Nominal kuna/euro exchange rate • FDI (stock or flow?) • Croatian import tariffs Model: dynamic panel data method – estimation via GMM

4. Findings Export function: Import function: • Import tariffs expected sign but negligible effect • For Croatian exports, competitiveness works through prices, not quality of goods. • Exchange rate does not have a strong role in determining export flows, while it contributes to import growth. • Use of currency depreciation as an export promotion tool is not validated.

5. Good points of the paper • First, the paper asks a very interesting and relevant research question, which is of great importance for the Croatian policy makers. • Second, this paper is among a few papers that empirically deals with trade mechanics in Croatia. • The finding from this paper (if accepted as valid) raise important economic and political questions in Croatia (other transitional countries?). • The author shows good understanding of issues involved in trade modelling • Overall, this is a well-written, interesting paper with a potential to be a publishable piece of work.

6. Comments and questions This is a solid econometric exercise but... • The purpose of the paper has very little ambition (income and price elasticities) or is it to ambitious (HRK/€)? • What does this paper bring new to the literature about transitional economies? • Who will be interested in this paper? • What are the policy implications? • What should be done on fiscal and monetary front? • There is no explanation of Croatian economical and trade specifics. An investigation of these would substantially increase the quality of the paper! • Taking account of regional elements and previous knowledge of product and trade among ex YU and ex communists countries is necessary. • What happened in 2003-2004 (reversal of trend)? • Page 3 – What is the reason of Croatia’s low competitiveness and pronounced imbalance in international trade?

7. Comments and questions • Although the author is aware of Croatian specifics the paper still uses the most standard setup, why? (potential to be the first and original)! • For some strong presumptions there is little backing in the literature • Better literature overview – what are the findings of the papers that are mentioned in the overview (some of them are contradicting the findings in this paper) • Wide range of elasticity coefficient 0.17-5.3 why are they not presented? • Are the coefficients stable? Robustness check? • Given the nonstationarity of variables, cointegration analysis seems an appropriate technique for uncovering the existence of a long-run relationship involving the export price, domestic cost, and the exchange rate!

8. Comments and questions • What about regional prices (a lot of empirical proofs about competition among transitional countries (TC) for the placement of goods in developed countries - see Faini, Clavijo, Senhadji-Semlali (1992) ) • As a result of these factors, exchange rate policies lose much of their effectiveness, demand from developed countries is again a major determinant of TC export performance. • Devaluation is an effective tool in this respect when used by one TC, if employed by a group the effects are wiped out! • Devaluation though may still be an effective tool to promote efficient import substitution, bring a more efficient allocation of resources and by avoiding unrealistic appreciation, deter capital flights from the onset. • Importance of regional effects!

9. Comments and questions • The paper should take into account that placing Croatian goods on foreign markets were caused mainly by (1) a breakdown of the ex YU and communist markets, which had absorbed the bulk of Croatian exports prior to 1991; (2) the still low competitiveness of Croatian production; (3) changing ownership relations in firms and unfinished company restructuring (4) war • Are there any structural breaks in the data? • What structural equations are used in the paper? • The imperfect substitutes model (Goldstein, Moris, Khan 1985)? OR some extension? • Other models: Greenhalgh, Taylor and Wilson (1994), Blake and Pain (1994), Pain and Wakelin (1997), Greenaway, Souza and Wakelin (2002), Algieri (2004)...?

10. Comments and questions • Traditional imperfect substitutes model: domestic cost and foreign prices are treated as exogenous to exchange rate changes. • Such an assumption may be justified for some group of products and possibly in the short run. • This seems inappropriate given the pervasive effects of exchange rates on production costs through imported inputs and indirect cost competition in the world market. • For instance, the prices of commodities are usually denominated and invoiced in dollars. Thus, a depreciation of the currency vis-a-vis the dollar will increase the non-US dollar prices of commodities, which in turn will raise production costs and export prices. • In traditional trade models, a currency depreciation deteriorates the terms of trade, which tends to increase the trade balance and aggregate demand. Unless the returns to scale are constant, unit costs are likely to vary with changes in aggregate demand.

11. Comments and questions • FDI variable: • The paper uses the logic behind the use of FDI as a proxy for competitiveness and productivity (taken from Czech Rep.) – not appropriate since in CZE it went into manufacturing industry in CRO mostly service sector without export potential! • Prices variable: • “...relatively more expensive imports which will work to lower imported quantities” not so straightforward, what about product like (cars, phones, computers, building machinery...)? • Bias in obtained results due to both homogenous and differentiated goods within sectors – solution: use indexes of product differentiation - see Chiarlone (2000) • Focus on main trading partners not the whole world

12. Comments and questions • Income variable: • World total GDP – main trading partners GDP? • Tariffs variable: • Tariffs in foreign markets, EU quotas, non tariff impediments to exports from Croatia – significant but not taken into account • By concentrating on main trading partners import tariffs could be accounted for (not an easy but a extremely important task!) • What about the other side of the coin – subsidies, completely unchecked (why?) • See the current cheese crisis imported from EU!

13. Comments and questions • Exchange rate variable: • Check the real effective exchange rate index based on the CPI and related to the currencies of the given trade partners • During the investigated period kuna is appreciating against the euro, there is no strong depreciation so how can any conclusion be drawn about the effects of kuna depreciation? • Exchange rate also works through price variable, how can the paper say that exchange rate depreciation is unimportant in exports? • Wansing Hung et al. (1993) found feedback into the exchange rate from the other variables is present in most countries. The feedback tends to make the exchange rate innovations decay rapidly. • In estimation, a simultaneous equations approach seems necessary to properly estimate pass-through processes since exogeneity assumptions are clearly violated in most countries. • Be careful this is a overly simplifed analysis to conclude anything about exchange rate mechanics!

14. Comments and questions Some of the variables that are omitted but should be checked: • monetary policy interest rate • economies of scale • supply-side based factor shaping the intensity of exports and imports is economies of scale – see Krugman and Obstfeld (2003) - approximated by material inputs. • change in productivity • Capital (at constant prices) per unit of labour - reallocation of production to industries that use higher capital per labour leads to an increase in exports! • Tariff rates levied abroad on Croatian exports • Monetary policy (stock of real M2) • Material input values adjusted for price changes • Croatian price changes in industries - measuring the intensity of nominal convergence • indexes of quality and supply reliability - Greenhalgh, Taylor and Wilson (1994) • Availability of output as a determinant of exports (Algieri, 2004)

15. Comments and questions • A lot of studies emphasize the importance of market structure - the market share, market concentration, substitutability between domestic and foreign variants of a product, high sunk cost of production, the level of trade barriers, etc. • See Dornbusch (1987), Baldwin (1988), Dixit (1989), Froot and Klemperer (1989), and Feenstra (1989). • These effects are expected to be more important in less than perfectly competitive market (exporter follows the competitors’ price) such as Croatia. • Where is out-of-the-sample forecasting to validate the findings?

16. Comments and questions • What is the export content of imports? • Is there any correlation between exports and imports within the same sectors (intra-industry trade)? • As the negative sign of import prices reveals, the import penetration strategies of exporters are based on competition in product price not quality – this is strange (opposite is found for other transitional economies) – what is the meaning of this? • How does Croatian production compete with imports? Test this by testing Croatian price changes in industries in the import equation. If it has a positive coefficient it means that a domestic price increase supports imports

17. Conclusion • Foundations have been laid but a lot of work and sleepless nights still ahead! • Congratulation to the author on having the courage to chose a very demanding but important field of research for any country in the world. • If the author wishes to pursue this field of research I wish her the best of luck!