Abstract
Over the past two decades, trade integration has increased rapidly within the world economy and tight supply chain networks have been formed, particularly within Asia. Have these developments strengthened the propagation of shocks, and more broadly the synchronization of business cycles between economies? Based on a unique dataset, we provide a new answer to this old question: increased trade integration in value-added terms does increase the synchronization of growth cycles between economies, while gross trade linkages do not seem to matter. This effect appears to be stronger in crisis times. A related finding is that growing dependence of economies, especially within Asia, on Chinese final demand in value-added terms is amplifying the international spillovers of growth shocks in China.
Kevin Cheng, Romain Duval, and Dulani Seneviratne
The relationship between trade integration and business cycle synchronization is theoretically ambiguous and is therefore mainly an empirical question. Earlier research (notably Frankel and Rose, 1997, 1998) found a positive impact, but more recent studies have questioned the validity of earlier results, which had not accounted for fixed country-pair factors and common global shocks, and thereby may not necessarily have identified a causal relationship. Controlling for these omitted factors, recent papers (such as Kalemli-Ozcan and others 2013 and Abiad and others 2013) find the relationship between gross trade integration and business cycle synchronization to be insignificant.
In our work (Duval and others 2014), we reassess this relationship by computing trade intensity in value-added rather than gross terms, building on the recent joint OECD-WTO initiative on trade in value added. Our logic is that gross trade data misrepresent trade linkages across countries amid increasingly important supply-chain networks across the globe. Value-added trade nets out bilateral trade in intermediate goods—unlike gross trade data, which count products multiple times when they cross borders repeatedly for processing purposes—and thus captures more accurately the value added embodied in bilateral trade. Furthermore, value-added trade includes indirect trade linkages via third countries—such as value added exported indirectly by country A to country B via intermediate inputs exported by A to C that are then used to produce a good exported by C to B. Using value-added trade data instead proves crucial to identifying a robust impact of trade on business cycle synchronization.
Stylized Facts About Business Cycle Synchronization and Trade Integration
Consistent with findings from other similar studies, we find that business cycle synchronization sharply increases in crisis times. The largest spikes occurred around the global financial crisis outside Asia, and around the Asian crisis of the late 1990s within Asia. However, even during normal times, business cycle synchronization—while much smaller—also shows an upward trend around the globe since the 1990s, especially in Asia (Figure 1, left).
Stylized Facts about BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: IMF, World Economic Outlook; and IMF staff calculations.Stylized Facts about BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: IMF, World Economic Outlook; and IMF staff calculations.Stylized Facts about BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: IMF, World Economic Outlook; and IMF staff calculations.Turning to trade integration, the most frequently featured trade variable in the literature is bilateral trade intensity, for which we follow the standard definition (the ratio of the sum of exports between a country-pair to the sum of their GDPs), except that we define it in a value-added sense. Measured this way, trade openness appears to have increased until the mid-2000s, and more so within Asia than elsewhere (Figure 1, right).
Stylized Facts about BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: Organization for Economic Co-operation and Development and World Trade Organization, Trade in Value-Added database; and IMF staff estimates.Stylized Facts about BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: Organization for Economic Co-operation and Development and World Trade Organization, Trade in Value-Added database; and IMF staff estimates.Stylized Facts about BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: Organization for Economic Co-operation and Development and World Trade Organization, Trade in Value-Added database; and IMF staff estimates.Vertical trade has also increased more in Asia than elsewhere, with China playing a pivotal role. The share of foreign value-added embedded in total exports has generally increased in Asian economies, particularly in East Asia reflecting the “China supply-chain” network. By contrast, value-added to/from Japan has generally declined. Furthermore, the nature of integration with partners differs between China and Japan, with China specializing comparatively more in downstream activities (such as assembling, even though China is now increasingly moving up the value chain) and Japan specializing in upstream activities (providing various intermediate goods as inputs). Finally, although the United States and the European Union remain by far the largest final consumers of Asia’s supply chain products, the importance of final demand coming from China has increased rapidly over the past two decades.
In addition to trade intensity and vertical integration, we examine other aspects of trade integration that are relevant for business cycle synchronization, such as intra-industry trade and similarity in trade specialization. Overall, the degree of intra-industry trade has barely increased across Asia, but, on average, it is slightly higher than in the rest of the world. It is especially high among ASEAN-5 economies (Indonesia, Malaysia, Philippines, Singapore, Thailand), as well as the degree of similarity of their trade specializations—although the latter has declined since the 1990s, possibly reflecting increased specialization along the regional supply chain. This would mean that if most shocks are industry specific, cycles should co-move more within ASEAN-5.
Reassessing the Relationship Between Business Cycle Synchronization and Trade Integration
To formally gauge the impact of trade and non-trade variables—such as financial integration—on business cycle synchronization, we employ a (country-pair time-series) panel econometric framework controlling systematically for country-pair heterogeneity and common global shocks. Our analysis uses annual value-added trade data for 63 countries, including 34 advanced economies (7 of which are in Asia) and 29 emerging economies (8 of which are in Asia). We address endogeneity issues by applying instrumental variable techniques. The main results are the following (Figure 2, left):
Relationship between BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Source: IMF staff estimates.Relationship between BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Source: IMF staff estimates.Relationship between BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Source: IMF staff estimates.Bilateral trade intensity—in valued-added rather than in gross terms—is an important factor in explaining the synchronization of cycles. The effect is bigger in crisis times, suggesting that trade integration offers an important channel for propagating shocks across borders.
A higher degree of intra-industry trade and greater similarity in trade specializations has also led to greater co-movement. This suggests that industry-specific shocks are important and that economic cycles are likely to be more correlated among economies that have a similar economic structure.
The degree of vertical integration does not seem to have a distinct effect on synchronization over and above its impact through trade intensity. This could be because this additional effect is only relevant for specific supply shocks (such as natural disasters) and country pairs (such as the 2011 tsunami in Japan or the 2013 floods in Thailand) or because in many cases inputs are substitutable allowing supply chain disruptions to be mitigated.
Turning to non-trade variables, our empirical analysis also finds that greater banking and portfolio integration between two economies reduces their output co-movement most of the time, although banking integration does appear to increase the synchronization of cycles across countries during crisis times. This finding is supportive of the view that financial linkages may facilitate international reallocation of capital across economies in “normal” times, but may foster contagion in crisis times.
The Role of Spillovers from China
A further source of output co-movement among economies, especially in Asia, is the growing importance of China as a source of final demand for their goods and services. In its role as the “assembly hub” of Asia, China’s economy should not directly affect its trade partners much, since it primarily propagates shocks coming from advanced economies through the regional supply chain. But with China now being a growing source of final demand as well, it should have a bigger direct impact than in the past. Indeed, economies whose trade dependence on China’s final demand has increased over the past decade have generally experienced a greater increase in their cyclical co-movement with China during the period (Figure 2, right).
Relationship between BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: IMF, World Economic Outlook database; Organization for Economic Co-operation and Development and World Trade Organization, Trade in Value-Added database; and IMF staff estimates.Relationship between BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: IMF, World Economic Outlook database; Organization for Economic Co-operation and Development and World Trade Organization, Trade in Value-Added database; and IMF staff estimates.Relationship between BCS and Trade Integration
Citation: IMF Research Bulletin 2014, 003; 10.5089/9781498340045.026.A003
Sources: IMF, World Economic Outlook database; Organization for Economic Co-operation and Development and World Trade Organization, Trade in Value-Added database; and IMF staff estimates.Further (panel) empirical analysis confirms that economies, which depend more on China for their export of final goods and services, are more affected by growth shocks originating from China. Specifically, we find that a one percentage point decline in China’s growth may lower GDP growth in the median Asian economy by about 0.3 percentage point after a year, compared with 0.15 in the median non-Asian economy. This difference reflects the larger dependence of Asian economies on China, compared to non-Asian countries.
Implications for Asia in the Future
As trade integration continues to strengthen in the future in Asia and elsewhere, our analysis implies that business cycle synchronization should continue to rise. In addition, as China’s economy grows bigger and rebalances, growth shocks emanating from China are likely to further strengthen shock propagation and synchronization, particularly in Asia. By contrast, China’s role as a conduit for external shocks may diminish as its role as the region’s “assembly hub” continues to decline.
References
Abiad, A., D. Furceri, S. Kalemli-Ozcan, and A. Pescatori. 2013. “Dancing Together? Spillovers, Common Shocks, and the Role of Financial and Trade Linkages,” in World Economic Outlook, (Washington: International Monetary Fund, October), pp. 81–111.
Duval, R., K. Cheng, K-H. Oh, R. Saraf, and D. Seneviratne. 2014. “Trade and Business Cycle Synchronization: A Reappraisal with Focus on Asia,” IMF Working Paper 14/52 (Washington: International Monetary Fund).
Frankel, J. A., and A. K. Rose. 1997. “Economic Structure and the Decision to Adopt a Common Currency,” Seminar Paper No 611, The Institute for International Economic Studies (Stockholm: Stockholm University).
Frankel, J. A., and A. K. Rose. 1998. “The Endogeneity of the Optimum Currency Area Criteria,” Royal Economic Society, Vol. 108(499), pp. 1009–1025.
Kalemli-Ozcan, Sebnem, E. Papaioannou, and J. Peydro. 2013. “Financial Regulation, Financial Globalization, and the Synchronization of Economic Activity,” Journal of Finance, Vol. LXIII, pp. 1179–1228.
