Transcript The estimated effects of the euro on trade: Why are they below historical evidence on effects of monetary unions among smaller countries? Prof.

The estimated effects of the euro on trade:
Why are they below historical evidence
on effects of monetary unions
among smaller countries?
Prof. Jeffrey Frankel, Harvard University
NBER conference on Europe and the Euro,
Milan, October 17-18, 2008
Alberto Alesina &
Francesco Giavazzi,
Organizers
1
Introduction:
The status of the Rose finding and of
the first trade effects of the euro
To be discussed:
1. Rose’s (2000) famous gravity-model estimate:
monetary unions triple trade among members.
2. Critiques of Rose
3. First post-1999 results on effects of the € on European
trade patterns.
4. The key question: what explains the smaller effects of
the € to date relative to historical estimates
1. Country size?
2. Gradual adjustment over time?
3. Spuriously high previous estimates?
5.
Approach of this paper
2
Rose, “One Money, One Market”
•
Probably the most influential empirical paper in
the field in the last decade
The research was motivated by the coming EMU,
but estimates were based on historical data from
much smaller countries.
Findings
•
•
•
–
–
MU => tripling of trade among members
Fixed exchange rate in itself also =>
statistically significant increase in trade
3
Link to “Growth theme” of first part
of Dubrovnik conference
• Total trade/GDP is estimated to rise when a
country joins a monetary union.
• Combined with theories and empirical findings
regarding the effect of trade on growth, the
implication is a positive effect on growth.
• Frankel & Rose, QJE, 2002
• Sample estimate: If Poland joins the euro
openness eventually doubles, and income then
rises 40% over the subsequent 20 years.
4
Four critiques of Rose
, e.g., survey by Baldwin (2006) 1/
and Critique of the critiques, e.g., response by Frankel (2006)
1) Small-country results may not apply to large
countries.
Response: There has been no evidence of MU effect
varying with size.
2/
Admittedly no big countries were in MUs, pre-1999.
1/ Richard Baldwin, “The Euro’s Trade Effects,” in What effects is EMU having on the euro area and its member countries?,” ECB, Frankfurt, 2006.
2/ J. Frankel & A. Rose, QJE, 2002.
5
Critiques,
continued
2. Gross magnitudes
•
•
Tripling “seems too large to be believable.”
Van Wincoop critique:
Re-parameterizing the gravity-based estimate to fit a theoretical
model cuts the magnitude of the MU estimate below “x3.” 1/
Response -•
•
•
But the effect remains:
Statistically significant
On the same order of magnitude
• as the estimated effects of FTA, and
• as the estimated effects of borders (home bias), e.g., Canada-US 2/
Greater than thought 10 years ago.
1/ Rose & van Wincoop (2001): trade barriers are halved when joining MU. € => ∆ trade >50%.
2/ McCallum (1995), Helliwell (1998), Wei (1996), and Nitsch (1990, 1991)
6
Critiques,
continued
3. Endogeneity of the MU decision
Response:
–
–
Rose controlled for many third-variable determinants of trade
& MU (colonial past, etc.),
which should reduce endogeneity.
Some alleged cures worse than the disease
-- They either use poor instruments, or throw out the data-baby with the bathwater.
But endogeneity remains a likely problem: What if the
observed correlation arises because pairs that trade for
each other (for reasons not captured by controls)
decide to link currencies on Optimum Currency Area
grounds?
7
Critiques,
concluded
4. Cross-section comparative statics ≠
time series experiments
Response: Glick & Rose (2002), with a 1948–97
sample that includes countries that exited
MUs, found trade among members twice as
high in the currency union period as in the
subsequent 30 years.
.[1]
[1] Lags in adjustement of trade in gravity models may be longer than 30 years. Eichengreen and Irwin (1998), Frankel (1997) .
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First post-1999 results on effects of the
€ on European trade patterns
Micco, Ordonez & Stein (2003): for pairs of the 1st
12 EMU joiners, trade rose significantly.
•
•
•
≈ 15 % beyond what could be explained by growth, etc.
a range of 6 - 26 % (depending on dummies),
with a larger set of 22 industrialized countries.
“Preferred estimates” (with pair dummies): 4 -16%.
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Other studies of € effect on trade
• Bun & Klaassen (2002, p.1): “the euro has
significantly increased trade, with an effect of
4% in the first year” => a long-run effect ≈ 40 %
• Berger & Nitsch (2005) and De Nardis & Vicarelli
(2003) report similar positive results.
• Flam & Nordström (2006): 26% (1995-98 to 2002-05)
• Chintrakarn (2008): 9 to 14%.
• Consensus to date:
– results in 1st four years significant
– but “small”: ≈ 10-20% .
10
Results on effects of the € on European
trade patterns, continued
• No trade-diversion from non-members
– among MUs in general 1/
– from euro in particular (e.g., effects on UK, Sweden) 2/
• Difficulties disentangling MU from:
–
–
–
–
customs unions (EU) – UK, Sweden.,Denmark, & the 2005 Ten.
political (dis-) unions, e.g. Czech-Slovak, Yugoslavia, FSU
transition from socialism to capitalism, e.g., Slovenia
Re-orientation away from trade with USSR, e.g., Finland
1/ e.g., Frankel-Rose, 2002
2/ Begg, et al (2003), Micco, Stein & Ordoñez (2003), and Flam
& Nordström (2006).
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The key questions:
Are the effects of the € to date still smaller
than the historical estimates based on
larger sets of smaller countries?
If so, is that because:
• Time is needed for gradual adjustment?
• Small countries ≠ large countries?
• Earlier results are biased up by
endogeneity?
12
Approach of this paper
• Update gravity estimates of € effect
• while also imbedding recent European years in
panel data set of other MUs, e.g., from Glick & Rose
• Address each of the three thorny problems:
– Allow for lagged adjustment
– Test explicitly if MU effect declines with country size.
– Address endogeneity with a natural experiment.
13
Special cases to shed light on causality
• Ireland’s switch
– off of £ in 1979, and onto euro in 1999
– was a valuable example, the largest pre-1999.
– But separate trade effect not statistically significant
• Because covariance with joining EU was too close (Thom & Walsh, 2002)
• and dominated by long-term trend in intra-EU trade (Lane, et al, 2008)
• Estimation for Slovenia in 2007, when data permit
– will be a valuable example, as the 1st transition country to join €.
– But, again, we are unlikely to get enough data
to separate out the effects of € from effects of
• transition out of Socialist Yugoslavia
• joining EU
• Also Cyprus and Malta in 2008
14
Moreover, possible endogeneity is still with us
• The decision to join the €, by Slovenias or
Irelands, could be misleadingly correlated
with shift in trade pattern toward
continental Europe, either because:
– such a shift is a political goal, encouraged by
other means as well, or
– trade is shifting direction for natural economic
reasons, and policy-makers want to reduce fx costs
for importers & exporters.
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Reproducing the results in Micco,
Ordoñez & Stein (2002)
• They estimated the effect of € on trade patterns
during 1992-2002, for relatively narrow samples:
– Europe or, alternatively,
– all industrialized countries.
• Table 1 does successfully replicate the results:
–
–
–
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pairs of euro countries enjoy greater bilateral trade;
coefficient gradually rises in level & significance,
reaching about 15% in 2002,
after first appearing suddenly significant in 1998.
• Why does the effect show up the year before EMU formally
goes into effect?
– Same with FTAs.
– Explanation: businesses seek “first-mover advantage.”
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Table 1 --
Effect becomes
significant in 1998
Reaches 16% in 2001-02.
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EMU Impact on Trade (in %)
Finding: € effect reached 14-18% by 2001
Micco, Ste in and Ordone z (2003): EMU Impact on Trade
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
-2%
-4%
Time
D ev eloped S ample E U S ample
16
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Update of results, as 4 more years
of data have become available.
• The effect of the euro on bilateral trade remains
highly significant statistically during the years
2003-2006,
• but the point estimate is no longer rising.
• Rather, it appears to have leveled off,
≈ 0.15 in the EU-only sample, still very far below
the Rose doubling or tripling estimates.
– In the sample that includes all developed countries, the
euro effect is only ≈ 0.10.
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Table 2 --
Effect becomes
significant in 1999
Reaches 16% in 2001
Steady through 2006
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Now imbed in the complete data set
• 1948-2006
• 200 countries, including
– enough data to get sharp estimates
of parameters, and
– a fair number of monetary unions
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Do the effects of monetary union diminish
with the size of the countries involved?
• Add an interactive size term -- the product of the
respective country sizes and the CU dummy variable -• to see whether CU effects on trade are bigger for small
countries than for large countries, so that this might
explain the smaller effect in Europe.
• Larger countries do not experience smaller boosts to
intra-MU trade to a statistically significant extent.
• The effect of EMU on bilateral trade remains,
even after controlling for size.
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Mystery:
If neither time lags nor size explain
the gap between 15% and doubling,
then what does?
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In cross-section, EMU is estimated to increase intra-member
trade by 2-3 times, but only when entire data sample is used
The Effect of EMU on Trade: Different Estimators and Samples, 1948-2006
200%
180%
160%
140%
120%
100%
80%
60%
40%
20%
0%
-20%
Full Sample F ixed Full Sample O L S D eveloped SampleD eveloped Sample E U Sample F ixed
E ffec ts
Fixed E ffec ts
O LS
E ffec ts
E U Sample O L S
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We proceed step-by-step from our
reproduction of M-O-S, to see at which stage
the coefficients change
• Table 6 expands the dataset to 1948-2006, a panel with
almost 60 years of data, while retaining a separate
coefficient to distinguish EMU from others.
• The graph reveals that sample size is the crucial
difference between MSO & broader estimates.
• While estimates of the euro’s effect on trade continue to
linger around 10-25% for the developed & EU samples
that MSO used, they climb dramatically to .9-1.0 for the
full sample
• exponentially = 2.5-2.7, almost tripling.
• Estimates are highly significant, because there are more
data to work with now.
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6-10 years after monetary union, estimated effects on trade
from other MUs are virtually the same as from EMU,
provided estimation is on full sample of countries/years (1948-2006)
The Effect of Non-EMU Currency Unions and of EMU on Bilateral Trade ov er
Time:
F ixed Effects Estimators
700%
600%
500%
400%
300%
200%
100%
0%
1 Yr
P rior
-100%
to
N onEMU
CU
1 Yr
P rior
to
EMU
1-5
Y rs
P os t
N onEMU
CU
1-5
Y rs
P os t
EMU
6-10
Y rs
P os t
N onEMU
CU
6-10
Y rs
P os t
EMU
11-15
Y rs
P os t
N onEMU
CU
16-20
Y rs
P os t
N onEMU
CU
21-25
Y rs
P os t
N onEMU
CU
26-30
Y rs
P os t
N onEMU
CU
Full Sample F ixed E ffec ts E s timator
D eveloped Sample Fixed E ffec ts E s timator
E U Sample F ixed E ffec ts E s timator
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Mystery solved?
• We have uncovered the possibility that the large gap
is an artifact of the largely non-overlapping historical
periods analyzed in the Rose & M-O-S studies
(pre- & post-1999, respectively).
• Perhaps some parameters such as common border
and common language dummies are not estimated
well enough on smaller samples, affecting estimates
of €-area coefficient.
• Estimated trade effects of € as great as
trade effects of non-EMU CUs.
• Moreover, the estimated coefficient of EMU >
coefficient for EU or other FTAs !
27
But could all estimates of CU effects be
biased upwards due to endogeneity
of the currency decision?
• As our last task, we address endogeneity.
28
A natural experiment:
The effects of the French franc’s conversion to
€ on bilateral trade of African CFA members.
•
The long-time link of CFA currencies to the F franc has
clearly always had a political motivation.
–
So CFA trade with France could not reliably be attributed to
currency link,
•
•
perhaps even after controlling for common language, former
colonial status, etc.
But in Jan. 1999, 14 CFA countries suddenly found
themselves with the same currency link to Germany,
Austria, Finland, Portugal, etc.
–
–
No economic/political motivation. A natural experiment.
If CFA trade with these other countries has risen,
that suggests a € effect that we can declare causal.
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Results of CFA experiment
• Table 7.
• The dummy variable
representing when one partner is
a CFA country and the other a € country
has a highly significant coefficient of .57.
• Taking the exponent, the point estimate
is that the euro boosts bilateral trade
between the relevant African and €
countries by 76%.
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Conclusions
1. Update of first estimates of effect of € on intra-EMU trade
shows the coefficient in 2003-2006 remained significant
and steady at the level attained in 2001-02.
2. But it didn’t continue to rise. No evidence that lags
explain the big gap between effect of € (15%) and earlier
estimates of effects of other Monetary Unions (x2 or x3)
3. There is also no evidence that the gap is explained by
a MU effect that diminishes with country size.
4. The natural experiment of the CFA suggests that the high
estimates of effects among small or poor countries
have not resulted from endogeneity of currency decisions.
5. Solution to the mystery?
1. Apparently the additional data from the full data set is necessary
for accurate estimates of the parameters.
2. Perhaps the € effect is as large as effects of other MUs after all;
3. but the mystery is not yet completely solved.
31
Thanks to thank Clara Zverina, who provided excellent research assistance.
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