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Economic and Monetary Union in Europe (EMU) has recently been the source of a lot of pain. EMU’s benefits – particularly economic benefits – often seem a lot harder to see and measure. Since monetary union reduces transactions costs between its members, it could, in principle, stimulate trade. Has it? There has been considerable dispute concerning the size, if any, of this trade-stimulating effect of EMU, or indeed of the effect of any currency union on trade. In their recent survey of the literature, Head and Mayer (2014) write:
“The trade effects of common currencies have been the subject of controversy. Our mean over 104 estimates is 0.79, which corresponds to a doubling of trade. This is substantially smaller than initial estimates by Rose (2000) who put the currency union coefficient at 1.21, implying more than tripling trade. However, the meta-analysis average is substantially larger than the preferred estimates of some recent work. Baldwin (2006), synthesising a stream of papers focusing mainly on the Euro, puts the currency effect at about 30%. Santos Silva and Tenreyro (2010) find virtually no effects on trade for the Euro, after taking account the high level of trade integration of Eurozone members even before they formed a common currency. Berthou and Fontagné (2012) use firm-level exports by French firms and find a weakly significant 5% effect, coming mostly from average exports by the most productive firms. Frankel (2010) finds a more optimistic 15% increase of trade that takes about 5 years to take place, and then stabilises.”
As some of the early contributors to this work, we bear much responsibility for this situation. In our European Economic Review (2002) paper, we used pre-1998 data to estimate the effect of currency unions on trade using (then-) conventional gravity models. We concluded:
“During this sample a large number of countries left currency unions; they experienced economically and statistically significant declines in bilateral trade, after accounting for other factors. Assuming symmetry, we estimate that a pair of countries that starts to use a common currency experiences a near doubling in bilateral trade.”
It seems an appropriate time to reconsider our earlier opinions. We now have 15 years of data on the currency union that people care most about, EMU; there have also been considerable methodological advances. Are our critics correct in assessing the EMU effect on trade as small?