What Wall Street Doesn’t Understand About International Trade ..(Importance of local neighborhood)

An excellent summary of a paper  which shows how local neighborhood and immigration roots matter more for international trade than anything else. The paper is here.

Making the best international trading decisions may be as easy as taking a stroll around the local neighborhood.

A recent research paper states that it’s possible to predict whether a US firm will trade with any given country by studying the ethnic makeup of the nearby community, according to new research. What’s more, firms that correlate their international trading activity with the local ethnic community significantly outperform those that don’t—a fact that has escaped notice of financial analysts.

The findings could help Wall Street make better earnings performance forecasts, according to the authors of Channels of Influence, by Harvard Business School Associate Professors Lauren H. Cohen and Christopher J. Malloy, and Umit G. Gurun, an associate professor at the University of Texas at Dallas.

The authors run this terrific natural experiment to figure importance of ties in trade:

Establishing scientific proof required a situation in which the team could exogenously change the ethnic population of metropolitan areas near firms. The legality and feasibility of such an experiment seemed unlikely from a human rights perspective.

However, the researchers decided to focus on a specific period in US history in 1942, following the Japanese attack on Pearl Harbor, when the United States forced more than a 100,000 Japanese Americans to relocate from their homes on the Pacific coast to internment camps in other parts of the country. Not knowing how long the internment would last, many of the internees hurriedly sold their houses and assets before leaving. And so, when they were freed a few years later, many no longer had homes. Others tried to return to the West Coast, only to find that they faced hostility and violence from their neighbors. As a result, after they were freed a few years later, many internees ended up resettling in the regions surrounding the internment camps—including Arizona, Arkansas, Idaho, Wyoming, and Utah. Thus, the Japanese American populations in these areas grew significantly and suddenly.

“The Japanese population in Arkansas in 1940 was literally 3 people,” Cohen says. “With the internment camps, the government increased that population by almost 18,000. For sure, this was a huge exogenous shock.”

The researchers then looked solely at the international trading activity of firms located near the internment camps that were exogenously shocked with the increased Japanese population. They found that these firms traded significantly more with Japan, thus establishing the causal link between the exogenous population change and trade decisions. When additionally examining only those firms formed before 1946 (when the internment camps were evacuated), they found similarly large impacts on trade with Japan. “We can link the causal effect from the immigrants to the firm trade decisions, even 60 years later,” Cohen says.

 Superb…

Historically, Wall Street has failed to consider the local ethnic population trading strategy when assessing the value of a firm. In fact, the researchers found that analysts are significantly less accurate in their earnings forecasts on “strategic” trading firms than on non-strategic firms.

“With nearly 50 percent of sales being driven by overseas sales—and the surrounding population being a big driver of that activity—understanding this is crucial to understanding the value of a firm,” Cohen says.

We could actually see if we can draw similar experiences in India…Do firms trade more with firms which have affinity ties? Intuitively it sounds yes but empirically?

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