The Minor Mystery of the Euro’s Trade Effect

The predilection for More Trade

 I do not consider an increase in inter-country trade a good thing in and of itself, though that view is common among economists and in the media.  For most economists increased trade reflects a putative more efficient international allocation of resources derivative from competition on a global scale.  For the media, the enthusiasm frequently involves trade’s alleged employment generating effects, derivative from mercantilism and associated with assessing trade deficits as a prima facie problem of a country "living beyond its means".  Slightly more sophisticated is Adam Smith’s “vent for surplus” that sees trade as the outlet for what cannot be sold domestically.

 Rarely noted is that free trade theory is consistent with a decline in bilateral trade due to the likely possibility of different demand preferences between countries and, more esoteric, re-switching of techniques.  Except in technical articles one tends to find the blanket generalization that liberalising trade increases bilateral and multilateral flows and that is unambiguously a good outcome.  In that context I look at EU trade patterns since the euro’s use became generalized in the early 2000s.

 A common currency for the European Economic Community, seriously discussed when the Cold War divided the continent, was part of a broad and deep political process to forge unity in Western Europe.  However, in the early concept of a common currency, in the Treaty on European Union (1993, also known at the Maastricht Treaty) its specification is clearly economic, part of the commitment to “sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy”  (Article 3, Section 2).  As Jeremy Smith and I have argued, the reasonable interpretation of “highly competitive” is that it implies being export competitive. 

 Whether or not EU policy as implied by the treaties increased export competitiveness, there are obvious reasons to expect the introduction of the euro to facilitate trade among its users, now almost twenty countries.  First among these is lower transactions costs in trade among euro users, which in itself could reflect trade “diversion” not greater efficiency.

 The Mysterious Switch

The chart below shows an index of exports of all EU member countries in constant prices, among themselves and as a group with non-EU countries.  At the end of the time period, euro users included 19 countries and nine non-users, with the former accounting for slightly less than eighty percent of intra-EU trade in 2018.  All the largest trading countries used the euro except for the United Kingdom.  Prior to the Great Crash of 2008-2010, the two trade categories behaved as expected.  Intra-EU trade increased by substantially more than trade with non-members before 2008, as the transactions cost effect would predict.

 However, after 2010 the two categories reverse, with extra-EU exports increasing by substantially more than intra-exports.  For 2018 as a whole, extra-EU exports rose 26% compared to 2010, while intra-exports increased by 16%.  After 2010 other influences overwhelmed any common currency transaction gains.   

 If we begin with the lowest point in late 2009, the growth of extra-EU exports from the 28 countries increased by substantially more than for exports among themselves, 47% compared to 28%.  These numbers suggest that the extra-EU export demand was strong enough to overwhelm common currency benefits to trade.  European Commission fiscal austerity policies provide a possible reason for weaker intra-EU export demand.  Country level trade statistics allow a closer look at that possibility.

The constant price statistics do not disaggregate across member countries or between the 28 EU members and the 19 euro users.  We can disaggregate in current prices, which I do in the table below.  It covers both exports and imports.  Given the very low rate of inflation after 2010 in almost all countries and globally, the difference between current and constant price trade flows is unlikely to be substantial.  These numbers in current prices give us further insights when we note the obvious generalization that country demand is a major factor determining import growth, while trading partner demand tends to determine exports.

Source: Eurostat. “Intra” refers to trade among the 19 eurozone countries. “Extra” is trade with non-euro users in and out the EU.

Author's calculations made from trade data disaggregated by "direction of trade" (ie., by country and groups). Note: IntraM is imports within eurozone; ExtraM is imports from non-EU partners; IntraX is exports within eurozone; and ExtraX is exports to non-eurozone. Numbers in bold indicate cases in which intra-trade increased faster than extra-trade.

 For all 28 countries, intra-exports and intra-imports grew at almost the same rate, which one would expect (5.0% and 5.2%).  As we would expect in a customs union (due to the transaction cost effect), imports from non-euro sources grew slower than among euro users, 4.5% for all 28 countries, 4.3% for Euro zone members and 4.8% for EU members with national currencies and non-EU countries.  The last two numbers come as a bit surprising in that we would expect intra-imports to grow faster for those partners using the same currency, which is the case, though the difference is not great.  For well over a majority of EU members, intra-imports grew faster than extra-imports, and for four of the five largest eurozone countries (not Italy).

 A strikingly unexpected result appears with exports.  In 26 of the 28 countries exports to non-EU countries grew faster than to other EU members, the exceptions being Sweden (no difference) and Bulgaria.  More surprising yet, the larger differential is for eurozone countries, 7.1% to non-EU trading partners compared with 4.6% within the currency union.

 Following the clues … towards fiscal austerity

To restate the mystery, we would expect membership in a common currency arrangement to increase trade among members more than trade with the rest of the world.  That is one of the expected outcomes of introducing a common currency because of its expected effect on transaction costs.  However, in the euro zone since the Great Crash exports among members has grown slower than exports to non-euro countries, both within and out of the EU.

 The obvious clue to explain this minor mystery is the implication of trade patterns that intra-euro aggregate demand has been weaker than rest of the world demand.  The clue leads to the policy of fiscal austerity introduced across the eurozone beginning in 2010.  It is highly probable that this fiscal restraint depressed domestic growth, thus reducing the demand for imports which are simultaneously intra-eurozone exports.

 Over two decades, 2001-2017, eurozone export growth to non-euro markets increased at over 7% annually, which some may take as an impressive performance.  However, this was considerably slower than for the nine EU members now using the euro.  Without an expansionary fiscal framework it appears that the eurozone s not an impressive driver of exports, neither within itself nor with non-eurozone partners.