In or Out: Does It Matter? An Evidence-Based Analysis of the Euro’s Trade Effects

Economics played little role in the decision to create the euro - politics was king. Going forward, however, economics moves to centre stage. In a new Report published by the Centre for Economic Policy Research (CEPR) titled 'In or Out: Does it Matter? - An Evidence-based Analysis of the Trade Effects of the Euro', Richard Baldwin makes an analysis of how European Monetary Union has affected the volume of trade for euro area countries and the rest of the EU. Baldwin argues that the implications for potential joiners are straightforward, but perhaps unexpected.

The key finding is that the EU15 'outs' - Britain, Sweden and Denmark - have suffered no loss of trade into the euro area since 1999 but rather have seen their exports to euro area nations expand: +7%, controlling for other factors. Furthermore, the trade creation among countries that entered EMU was modest: +9% controlling for other factors. This is due to the fact that euro area membership has acted like a unilateral trade liberalisation by the 'ins', which boosted their imports from the 'outs' almost as much as their imports from fellow euro-users. The finding of positive external trade creation and modest internal trade creation implies that joining the euro area would have very small effects on the 'outs' exports. Because the euro area already exists and encompasses three-quarters of the EU 25's GDP, the export prize will be very small for nations who join the euro area.

The export gain for countries considering joining the euro is limited to the difference between the internal-trade-creation number of 9% and the external-trade-creation number of 7%, and this only in respect to other users of the euro. The joining nation's imports, by contrast, will rise by 9% from its fellow euro area members and 7% from the remaining 'outs'. The straightforward implication of these two facts is that the joiner's imports should rise substantially more than its exports.

If the UK were to join the euro on its own, Baldwin finds that the best-estimate figures suggest that its exports would rise by $3 billion while imports would rise by $18 billion.

The figures for Sweden and Denmark are similar, although of course much smaller given the much smaller base-level of their trade. The extra sales to the euro area would amount to about 1% of total Swedish exports, while the extra sales by EU nations to Sweden would amount to about 5% of total Swedish imports. The corresponding Danish numbers are 1% and 6%.

The small increase in trade between countries that switched to the euro weakens the political case for British, Danish and Swedish membership in the euro area while the small size of the pro-trade effect weakens the economic argument.

Overall, the Report produces seven key findings:

The pro-trade effect of the euro is modest: somewhere between 5% and 15%, with 9% being the best estimate.

This effect happened very quickly, appearing in 1999.

The effect was not exclusive; euro-usage boosted imports from non-euro area nations almost as much as it boosted imports from euro area partners - in other words there was no trade diversion but rather external trade creation in addition to the internal trade creation. The best estimate of the external trade creation is 7%. The best empirical evidence suggests that this applies only to the euro area imports, but some evidence suggest that it applies to euro area exports as well.

The euro's pro-trade effect involved little or no convergence in euro area prices despite the jump in trade flows.

New research in this Report suggests that reduced transaction costs were not primarily responsible for the pro-trade effects; instead it was caused by the export of new goods to euro area economies. The mechanism driving this may have been a reduction in the fixed cost of introducing new goods into euro area markets.

The pro-trade effect varies a great deal across nations; Spain seems to have been the biggest gainer while Greece's gain is estimated to be nil or even negative.

The pro-trade effect varies greatly across sectors, with the gains concentrated in sectors where average productivity increases with output such as machinery and transport equipment, and chemicals. Beverages and tobacco was the biggest gainer, but this may be due to spurious factors, such as VAT fraud.