Long-Run Drivers of Current Account Imbalances in the EU: the Role of Trade Openness

Giuseppe Caivano and Nicola Daniele Coniglio Università degli Studi di Bari “Aldo Moro”

Ancona, International Conference – December 17-19, 2015

Outline of the Presentation

1. Stylized Facts2. Motivation and Literature Review3. Long-Run Drivers of Current Account Imbalances4. Trade openness and CA imbalances: what are the

mechanisms?5. Data and Methodology6. Results and Inference7. Conclusions

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Stylized Facts• During the last decades, the

Euro area kept a substantial current account balance (differently from the U.S. case) at the aggregate level

• However, imbalances and divergencies arise across EU countries

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Motivation and Literature ReviewWhy openness matters?- firms operating in international trade are typically more productive and skilled-intensive than firms operating in the domestic market only (Melitz and Ottaviano (2008), Bernard et al. (2007) and subsequent studies);- (large) importers/exporters are less sensitive to exchange-rate fluctuations (imperfect pass-through) (Amiti et al. (2014) AER, Bernini and Tomasi (2015)

These micro-level evidence suggest that at the macro-level different degree of openness might translate into heterogeneous reactions to common/similar shocks across countries.

The goal of this paper is to investigate the role of a country’s degree of trade openness in explaining the heterogeneous pattern of ca imbalances in Europe. (most related studies: Belke and Dreger (2013) and Gossè and Ferranito (2014).

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Long-run drivers of current account imbalances

• Income channel and financial flowsIncreasing financial integration weakens the connection between internal investment and savings (Feldstein and Horioka, 1980).With integrated markets, lower income countries can borrow more in order to converge towards high income one (Blanchard and Giavazzi 2002, Lane and Pels 2012, Ahearne et al. 2007)

• Competitiveness channel A higher real exchange rate makes domestic tradable goods more expensive with respect to foreign goods Arghyrou and Chortareas (2008) , Blanchard (2007), Belke and Dreger (2013).

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Long-run drivers of current account imbalances

• Fiscal policy and government debt channelA higher government fiscal deficit would generally translate into lower domestic savings and, in turn into a higher current account deficit (or a lower current account balance) (Feldstein (1987)).

• Demographic channel Countries with different old-age dependency ratios can have different saving and consumption dynamics, influencing current account positions (Chinn et al. (2003))

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Trade openness and current account imbalances: what are the mechanisms?

Productivity and product differentiation channels

i) A higher trade openness improves the economy’s ability to reorganize production in case of adverse shifts in unit labour productivity and relative prices (Cox 2007, Neary 2009 and Navas and Licandro 2010; Chen et al. 2009; Mody and Ohnsorge 2007);

ii) international firms are generally more efficient than purely domestic ones (Melitz and Ottaviano 2008, Mayer et al. 2001);

iii) More open economies are relatively more specialised in ‘differentiated products’ (higher market power) (Hummels & Klenow 2005; Galstayn & Lane 2007)

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Trade openness and current account imbalances: what are the mechanisms?

International production fragmentation channel

More open economies are also generally more integrated into global value chains: large exporting firms are also large importing ones and are more likely to absorb changes in competitiveness compared to less integrated firms. (Amiti et al. (2014) and Bernini and Tomasi (2015)) imperfect exchange rate pass-through

In conclusion, we should expect real exchange rate movements to have a stronger impact on countries with a smaller trade openness. (i.e. rer channel has a smaller impact)

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Data and Methodology • EU15 countries / time period: 1974-2011 (annual observations)• Given the presence of stochastic trends, panel cointegration methods are used: Unit Root tests (CADF, Pesaran (2007) and Cointegration tests (Westerlund (2007)) employed to explore cointegration properties of the series.• We estimate the cointegration vector by using the Pesaran et al. (1999) Pooled Mean Group (PMG) estimator. PMG allows us to constrain the long-run coefficients to be the same across group while it relax this restriction for the short-run, where intercept and slope are allowed to vary

•We employ the following (long-run) empirical equation on the determinants of current account (im)balances:

Where is a country-specific effect, i is the country index and t is the time period (1 lag included for each variable).

0 1 2 3 4it i it it it it itca y rer debt cred

0i

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Estimation of the cointegration vector (all countries)

Dependent variable: ca

Coefficients

rer -.2972***(.0426)

y -.0217(.0343)

debt .0558***(.0138)

cred -.0193*(.0115)

Hausmann testProb > Wald chi2

0.8353

Sample period: 1974-2011. Standard errors in parenthesis. ***, ** and * are intended as 1%, 5% and 10% confidence level.

Real exchange rate is the most important determinant of CA imbalances

Income channel appears to be not relevant

Government debt has a small but positive effect on trade balance (in contrast with the twin deficit hypothesis)

Credit channel’s impact is very small and significant only at 10% level.

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In this work, we split the sample in three sub-groups on the basis of trade openness [(X+I)/GDP] indicator computed using WTO trade statistics :

Low-openness -> France, Greece, Italy, Spain, UK and Portugal (<70% GDP)

Medium-openness -> Denmark, Finland, Germany and Sweden (from 80% to 110% GDP)

High-openness -> Austria, Belgium/Luxembourg, Ireland, Netherlands (>130% GDP)

The results are robust to alternative specifications of the country groups.

Does trade openness matter?

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Does trade openness matter?

RER impact increases as openness decreases

Countries with a smaller tradable sector are more sensitive to competitiveness changes

Financial inflows and trade growth outside-EU different credit and income channel effects

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Conclusive remarksOur results broadly confirms the real exchange rate is the most important determinant of ca (im)balances in the EU. But…its importance is highly heterogeneous: significantly stronger for countries with smaller trade openness.

From a policy perspective, our finding highlight an important source of heterogeneity in the context of the EU which might, at least in part, explain the divergent pattern of current account dynamics in the last decades.

We also find evidence of heterogeneity in the dynamics of other long-run determinants of current account imbalances.

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THANK YOU FOR THE ATTENTION!

Giuseppe CaivanoUNIVERSITÀ DEGLI STUDI DI BARI “ALDO MORO”

E-mail: giuseppecaivano@hotmail.com

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The heterogeneous impact of the other variables (credit and income channels) can be explained by the increasing trade growth and competition by emerging countries.

Competitive pressures associated to the rise of emerging economies (China, but also eastern European states) mostly affected the EU periphery which present a relatively low degree of openness.

In the last decades, exports from emerging Asian countries (especially China) have partially displaced goods exported by the EU countries like Portugal, Spain and Italy (Di Mauro et al. 2000, Chen et al. 2013) .

On the contrary, Germany and Austria have benefited from the growth of emerging countries (increased demand for machinery and capital goods) (Chen et al. (2013) ).

Additional mechanism: emerging countries competitive pressure

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Debt channel has also different impact: in more open economies, tradable sector allows private sector to offset fluctuations in public saving crowding out effect

Additional mechanisms: private vs public saving effects

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Unit Root Tests

Cointegration Tests

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A robustness check with different time periods

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Summary statistics for different openness groups

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