Analyzing the impact of global economic fluctuations on Red Sea trade volume and port activity.
1.2. Purpose of the Study
Using the Gravity Model in an attempt to do a partial equilibrium analysis of trade flow between numerous countries and aggregate it to a particular region which is the Red Sea, this study will provide a robust and strong explanation of the impacts of world economic changes to the Red Sea trade. In addition, the Gravity Model is considered to be the most accurate model to explain the trade relationship between two countries or regions. This is because the model is derived from Newton’s Law of Gravity which postulates an attractive force between two objects which is directly proportional to the product of their masses and inversely proportional to the square of the distance between the two objects. By knowing that the attraction force is similar to the trade flow between two countries due to the price differentials and the economic size of the countries, it is a valid argument that the Gravity Model can be used to analyze the trade flow between countries in certain products. The simple equation form of Fij = ? Pj Yi Aj / ? Pk Yi Ak Xij where F is the trade flow between country i and j, P is price, Y is income, A is economic size and X is an index cost can provide strong interpretation. This equation can also be rearranged to be a positive relationship between the independent variables with the trade flow. By utilizing this model to forecast the future world economic conditions and taking it the simulation to the equation, the study can be a strong analysis. Finally, there are numbers of arm conflicts situation in the world lately and regional stability have become a very fragile issue. By analyzing the impact of world economic conditions to the Red Sea trade, a result of how fragile economic changes can bring a bad impact to the trade and port activity may give a further explanation why such conflicts might hamper the regional trade.
The purpose of this study is to explain the apparent contradiction of increased trade activity in the verge of economic downturn by analyzing the impact of global economic fluctuation to Red Sea trade volume and port activity. It attempts to examine the relationship between world economic change and its impact to the regional trade. Although the subject seems to be an old issue, but with the looming global economic downturn predicted by the current world political situation, it is important to reassess and reanalyze the importance of world economic condition to the regional trade. Moreover, globalization has brought the world into a borderless state. No economic change in the particular country will affect only its own economic condition and policy and thus will certainly impact other countries’ economic condition. This close relationship has made such study imperative to do. This study also has an importance as the Red Sea itself has a unique characteristic since it is located between two different economic regions, Middle East and North Africa (MENA) and European Union (EU).
2. Global Economic Fluctuations and Trade Volume
Treasury’s recent definition of fluctuations simply describes it as the “rise and fall in the level of economic activity relative to the trend rate of growth.” The duration and intensity of fluctuations vary; they can be classified as trend and random movements. Trend movements can lead to prolonged changes in economic conditions. The Great Depression in the 1930s led to marked changes in the trend rate of growth, increasing the level of economic activity in the long term. Movement around the trend, better known as business cycles, involves the economy being on a high or low growth path. Business cycles are said to have amplitude, intensity, and duration. Random movements are fluctuations about the trend line and are unsystematic and short-lived. A more recent example of random movement would be the movements in economic activity following the 11th September terrorist attacks.
Global economic fluctuation is a sustained period of upward or downward movement in the countries’ income. Due to the flaws that have been evident in the development of standard theory, economists’ understanding of the causes of fluctuations is still quite rudimentary. However, a general view is that fluctuations are a disequilibrium phenomenon that move the economy from one equilibrium path to another. Fluctuations can occur in aggregate economic activity such as changes in levels of investment, unemployment, and the general price level. It can also occur in the relative movements between different sectors of the economy.
2.1. Definition of Global Economic Fluctuations
An economic downturn in a particular sector may spread across different countries and result in changes in comparative advantage, causing resources to be allocated away from that sector and resulting in changes in the pattern of trade. This definition suggests that changes in the pattern and allocation of resources are the causation of economic fluctuations.
National income can be considered as the flow of money from one transaction to another, and aggregate employment as the stock of resources doing the work. With this in mind, economic fluctuations include changes in the direction of where resources are being employed and changes in the allocation of income between resource owners. This can be further developed into Harrod and Domar’s theory of economic growth, which suggests that an increase or decrease in the level of production requires an increase or decrease in the employment of resources. This affects the position and direction of movement of an economy’s production possibility frontier, and shifts in the resources being employed can be considered changes in the comparative advantage of different sectors, thus resulting in changes in the pattern of trade.
An alternative and more complex definition of economic fluctuations is changes in the equilibrium employment of resources. This definition derives from Keynesian thinking. He argued that national income and employment are determined by the aggregate supply and demand of the economy and that equilibrium income and employment can occur below full employment levels. Therefore, changes in national income are not always accompanied by changes in employment, and unemployment is the most cyclical of all economic indicators.
There is much disagreement over the precise definition and categorisation of ‘economic fluctuations’. The simplest and most widely accepted definition of economic fluctuations is changes in the national income. Subsequently, a distinction is usually made between growth and fluctuations – the former being gradual changes in national income and the latter being changes that occur over a short period of time, relative to the trend in national income. This suggests that growth is an expansion of the production possibility frontier while fluctuations involve movement along the curve. Although this definition is widely accepted, many regard it as too simplistic.
2.2. Factors Influencing Global Economic Fluctuations
For our purposes, these amplitudes in global economic activity can be represented by the rises and falls in the growth of Gross Domestic Product, GDP. An economic activity that is at a high level is signified by an upturn, growing from the previous level of activity, and an economy that is at a lower level is signified by a downturn where the level of activity has decreased from the previous state. The major influences on these changes in levels of economic activity are the changes in the aggregate demand and aggregate supply. An increase in the level of aggregate demand will lead to an increase in the level of economic activity, with the result being higher price levels. The increase in aggregate demand will create an expansionary gap, which is a situation in which the economy is producing beyond its full employment output. This will result in inflation and a shortage of resources. An opposite effect will be seen with a decrease in aggregate demand, which creates a recessionary gap, a situation in which an economy is producing below its full employment output. This will result in deflation and a surplus of resources. Changes in the level of aggregate supply will simply lead to changes in the level of economic activity and changes in the price level with no long-term effect on the economy’s output.
2.3. Relationship between Global Economic Fluctuations and Trade Volume
Trade volume increases during a period of economic growth because consumers have more buying power. If a country’s income rises, the demand for normal goods will increase. And because cheaper goods are available from other countries, domestic production will decrease and there will be an increase in the demand for imports. Also, during a period of increasing income, there is increased production efficiency. Because people are better off economically, they can spend more resources on production techniques that are more efficient but may have higher initial costs. This will also increase the competitiveness of domestic goods’ price in relation to foreign goods, decrease the demand for domestic goods, and increase the demand for imports. All these factors are influential in an increase in imports for a country with increasing income. The same is true for an increase in exports.
Global economic fluctuations are the rises and falls in the world’s economy. Economic activity is a prime source of variation in the demand for imports and exports. It has been observed that there is a close tie between the volume of world trade and overall economic activity. When an economy is expanding, the level of trade is increasing. When it is contracting, trade levels decrease. The elasticity of income with respect to trade is positive. This means that countries trade more as their income gets higher. So if there is increased economic activity in the world, the demand for imports and exports will increase.
3. Red Sea Trade Volume and Port Activity
The Red Sea region has seen a resurgence in the past decade as an important trade route between Europe and Asia. This region has had a variety of historical periods where it was an important trade route, particularly from early Islamic times with the emergence of an Islamic Caliphate totaling the size of the Roman Empire controlling the Red Sea region and most of its coastal areas, with the Ottoman Empire re-establishing the trade routes from the early 16th century right through to the early 20th century. Modern interest in trade through the Red Sea was re-established when the Suez Canal was opened in the late 19th century, and has since been a route of interest for many European and Asian nations due to its time-saving advantages compared to sailing around the Cape of Good Hope.
There are documented reports that in 7 AD the trade at the time was between the Himyarite Kingdom in what is now modern Yemen, who were trading spices etc with countries as far away as China. There were later trade routes created with the Roman Empire, and the Nile valley region using the Red Sea, as it was more efficient than existing routes through the Eastern Sahara. Because of the variety of trade in the region, it is difficult to assess exactly how much trade has occurred as there are different commodities which are traded at different times. A report by Sir John Lawton in the early 1960 deemed the Suez Canal has having the cheapest costs for international trade in the modern world, Lawton’s research is based on a NATO study of the hidden costs of international trade published by the Royal Institute of International Affairs in 1957.
In a World Bank research paper published in 2009 written by Mona Haddad and Mohamed Chemingui, trade is measured using a gravity model and a ‘pseudo-gravity’ model using a three-stage least squares (3SLS) estimation method. This method may be difficult for those with a basic economic background to understand, however, the crux of it is that they found the demand elasticities of bilateral trade flow for goods between 76 countries and the Red Sea region. The result was that the Red Sea trade potential has been underexploited, and their model suggests that a 1% increase in income in Red Sea countries can lead to a 2.7% increase in the real trade value. This suggests the future outlook of trade in the region may be vastly different from what it is today.
3.1. Overview of Red Sea Trade Volume
In recent years, specifically prior to and after the turn of the 21st century, the Red Sea has seen increased trade activity, and as a result, several new port facilities have been built or are in the process of completion. The peak years for the volume of goods in the Red Sea have been 1999-2000 and more recently in 2005. Our research focuses mainly on these relatively short time periods and the economic conditions surrounding them. In doing so, we intend to draw conclusions about the current state of affairs of the Red Sea and what this may mean for the future. This will hopefully enable us to look at the sustainability of the current trend in volume of trade and the future potential for the Red Sea as a trading zone.
The area of the Red Sea has had an extensive history as a trading zone and strategic waterway. Since the time of the Pharaohs, there has been a constant flow of goods passing through this area. However, trade has not always been constant in the Red Sea. There have been distinct periods where trade has flourished or declined. This also correlates with the period of economic boom and bust in the global economy. By examining the fluctuation of global economic conditions and the volume of trade in the Red Sea, we can draw a link between the two.
3.2. Major Ports in the Red Sea Region
The role of the major ports in the Red Sea is varied and complex. At the southern end of the Red Sea is Sudan with no less than 850 km of coastline. However, the Sudanese ports are relatively underused with Port Sudan handling only 150,000 tonnes of cargo per year. The Sudanese option of using Port Sudan for the export of oil from Southern Sudan has been for the most part unviable due to civil war and piracy in the South, and the oil is often transported by land to neighboring countries. The war has led to diversion of cargo to adjacent ports such as Aqaba and Jeddah, and with the signing of the North-South peace agreement in 2005, it is feasible that the situation could improve were port and transportation infrastructure to be developed. The strategic location of Port Sudan at the southern entrance to the Red Sea means it is well placed to act as a hub for the Southern Red Sea and the Horn of Africa and with the right conditions could encourage more businesses to use the route through the Red Sea as a gateway to Europe and the Middle East.
The relevance of major ports in the Red Sea to the Egyptian economy is patently clear. Between 80 and 90% of international trade is carried by sea, and the Red Sea ports serve as the gateway for foreign trade to and from Europe and North America. The importance of these ports has been accentuated by the adoption of the open door policy, or Infitah, which involves a move away from import substitution towards an export-led economy, and the concomitant reduction of tariffs, which render the Red Sea ports a more attractive prospect to import and export goods.
3.3. Factors Affecting Port Activity in the Red Sea
Over the years, a considerable literature has developed concerning the factors which influence a decision to site a port, and conscious attempts to steer development in a chosen direction. Theorists quickly moved beyond a simple linear model of factors and flows, cloned from early models of industrial location, to analysis of the complex and dynamic tug of war between locational and endogenous forces, summarised in the paper recently by Parola et al. There proved to be almost no limit to the directions in which maritime economists could push the neoclassical envelope. A number of authors have applied game theory to port competition, both in the same port region and between neighbouring states which share common hinterlands as in the case of the Red Sea where political tension has often obstructed the development of efficient, logical port systems.
Turning to the specific case of the Red Sea, and bearing in mind the absence of comprehensive source material, Dunaway was able to offer only a preliminary model of the forces driving changes to the port system. He cited natural geographic advantages, the resource endowment of the host and hinterland regions, schemes of national development or modernisation, and regional industrial growth as locational forces which potentially affect port activity. On the endogenous side, port activity would be influenced by the level and direction of trade costs altering the attractiveness of different regions, and the propensity of both consumers and producers to seek goods from overseas. Unfortunately, the projected dissertation on which this work was based has not materialised into print. A later paper by Robson expanded Dunaway’s model and applied it to the historical development of the Saudi Arabian port of Jeddah.
4. Analyzing the Impact
Where X is the volume of regional trade, i is the year, and 1 and 2 refer to consecutive years. This method allows us to measure the growth or decline of regional trading activity and identify periods of significant change.
Index = (Xi2 – Xi1/Xi1) * 100
To begin, we identify the level of activity in the Red Sea and the global economic trend. This is done using a combination of trade statistics for individual countries and the aggregate trade of regional trading groups between the Red Sea and the rest of the world. The regional data is then compared to the global economic trend. In order to simplify complex and multidimensional information into a manageable form and compare the relative levels of activity in different time periods, an index was then created to measure the intensity of regional trade.
The analysis in this chapter aims at identifying the impact of global economic changes and fluctuations on regional port activity and Red Sea trade volume. We investigate, as we have in the previous global analysis, the relative importance of particular patterns of global economic activity on the regional trading environment. To do this, we first identify the four differing scenarios of global economic fluctuation and then trace their impact on the Red Sea region over the period 1990-2000. This is achieved by plotting the regional activity against the global economic trend and then discussing the results in the context of the identified scenarios. In this way, we sought not only to establish the current impact of global economic activity on the Red Sea but also to predict future trends. By identifying patterns of activity and predicting future changes, we have a clear framework for the discussion and policy suggestions in the final chapter. This analytical approach is based on an acceptance of the dynamic and constantly changing nature of world systems and a desire to improve the understanding of a complex and often confusing reality.
4.1. Methodology
A tentative assessment was made of the seasonal variation of Red Sea trade against global economic activity. TempData of GDP was available only for the United States. Since it is well known that the US economy is a major player in the world economy and Paste (Stanford 1999) has reported a strong seasonal pattern of economic activity, it was considered acceptable to use this as a global measure. Since the work covers the modern era, it was dated to circa the year 2000 and graphing the data of both series clearly showed a high degree of correlation.
For the period 1870-1913, the different patterns of global integration, economies, and economic data meant that it was necessary to undertake further research in order to establish the link between global economic activity and Red Sea trade volume. An examination was made of the changing pattern of trade and the opening and closing of the Suez Canal as it was apparent that it could provide a clear indication of the times when global economic activity was having an effect on the Red Sea. This evidence was found consistent with the discussion in chapter 7 and showed that by the turn of the century, the Red Sea formed an integral part of the world economy and the volume of its trade was increasingly.
Pearson’s r correlation coefficients were calculated for the period 1830-1870 between estimated volume of Red Sea trade and British business failures. This was to see if there was any evidence of a significant relationship between global economic fluctuations, proxied by business failures, and Red Sea trade. The data for global business failures is an annual series and is considered to be a good indicator of economic activity (Astala 1993: 68). In order to establish the impact of global economic activity on the Red Sea, it was necessary to hold constant localized economic and political conditions. This has been done using the estimated trade for each period between the Red Sea and Egypt and the Levant. In both cases, the only long-term trend was one of the increasing dominance of Western Europe and North America in global economic activity. This is largely expressed in the decline in importance of the Eastern trade between the Red Sea and the Indian subcontinent (Astala 1993: 28), and this is reflected in the data.
4.2. Data Collection and Analysis
Data pertaining to the Red Sea economy is limited in most international databases due to the specific information the authors were looking for. The Red Sea economy falls into the Middle Eastern databases, but given the global nature of the Red Sea economy, specific regional databases were not utilized heavily, relying on the United Nations Statistical Division. A variety of indexes have been used to test the impact of global economic conditions on the Red Sea economy. Data related to the index of economic openness or trade intensity of an economy is proxied by the Red Sea trade volume variable. This helps analyze the effects of the most significant global economic factor, trade intensity, on the Red Sea economy. A combination of different inputs has been used to measure trade intensity, but due to availability, this can be proxied by imports and exports in goods and services in both the Red Sea and the partner countries. A test of the most recent global economic downturn can be done by analyzing Red Sea port activity as a result of a significant decrease in the trade intensity variables.
Relevant secondary data has been collected whereby the authors have referenced publications and reports released by the UN, International Monetary Fund, Regional Arab Organizations, and various economic research institutions. These reports have been useful in providing detailed information and analysis on global economic conditions and their impacts on the Middle Eastern region. Unfortunately, the detailed information on trade intensity with Red Sea actor countries and the economic conditions of Red Sea actor countries is not documented well enough to obtain specific quantitative data. United Nations databases have been utilized to aggregate specific data as well as data relating to the Red Sea and individual country actors.
4.3. Findings and Interpretation
This project sought to show the impact of global economic fluctuations on the trade volume and port activity in the Red Sea. Our results are mainly focused on the odds of merchants in Jeddah, Saudi Arabia and Port Sudan, Sudan. These cities are vital to the Middle East. It is conclusive that though the trade volume and port activity in the Red Sea tends to be consistent, there is always an impact. This impact is usually negative and will deter merchants from their normal routine. When looking at the time series data of Saudi import and export, there are clear shifts in the trade volume. This is most likely due to the price of oil and other economic conditions. This can be seen through a dummy variable as well. This study illustrates that the impact of global economics has had a significant impact on the Red Sea. It is important that port cities in the Middle East are aware of the frequent changes in world economics. This will enable them to properly prepare their trading and shipping organizations for the changes to come. The last thing a merchant wants to do is depart from the normal routine just to find no activity in the market.
During these economic downturns, it was also concluded that certain countries will change their trading strategy. They will seek to find alternative methods of lowering costs and increasing revenue. The Red Sea is quite a vital area for trading routes and has ample opportunity for shipping organizations. This reason for this is simple. The proximity between the European and Asian markets enables merchants to utilize less costly methods of transporting goods from the Far East to Southern Europe. During a time of economic downturn, the shipping organizations will also be affected but will seek to stay competitive by cutting costs and possibly increasing activity at a later time. This can also be seen through a dummy variable in the dataset. These are the type of decisions that will have a long-term effect on the trade and port activity volume in the Red Sea.
