The impact of intra-industry trade on business cycle synchronization in East Asia

Highlights

• This paper empirically analyzes distinctions between intra- and inter-industry trade indices.

• The co-movements of business cycles are influenced more through the intra-industry trade than by the total volume of trade.

• Increased business cycle synchronization, as one of the optimum currency area criteria, is overemphasized.

Abstract

This paper empirically analyzes distinctions between intra- and inter-industry trade indices. The research indicates that the co-movements of business cycles are influenced more through the intra-industry trade channel than by the total volume of trade itself. As trade integration among Asian countries increased, business cycle synchronization among these countries was expected to expand through trade transmission. Inter-industry trade resulting in higher specialization will induce less synchronized business cycles, while intra-industry trade could lead to increased business cycle synchronization. Moreover, I find that increased business cycle synchronization, as one of the optimum currency area criteria, is overemphasized.

Introduction

The export-oriented growth path of East Asian economies highlights trade as a leading candidate of business cycle transmission. Could Asian emerging economies be decoupled from the European Union (EU) and the United States? How much does international trade transmission affect business cycle synchronization? Would greater trade flows between two countries cause greater business cycle synchronization? This paper analyzes these questions, utilizing standard approaches based mainly on the framework of Shin and Wang (2003). Data from eleven Asian countries, the Euro zone and the United States are used to discuss and determine trade integration and business cycle synchronization.

The discussion of business cycle co-movement originated with a series of correlation studies. The basic measure of co-movement between time series is a classical correlation, which is also commonly used in business cycle correlation research. At the same time, there is a longstanding concern regarding transmission channels through which business cycle fluctuations in one country are transmitted to other countries. The issue of business cycle synchronization is also relevant in the context of the possible formation of a currency union within East Asia, which has been revived in the wake of the Asian Crisis. A great deal of literature has been motivated by the implementation of optimum currency area (OCA)¹ criteria in the context of the pros and cons of regional monetary union or greater regional policy coordination (Willett, Permpoon, & Wihlborg, 2010). Based on the OCA argument of Mundell (1961), my empirical research begins by testing that countries with closer trade links tend to have more tightly correlated business cycles (Frankel & Rose, 1998).

As vertical specialization increases in East Asia, it is expected that the links in business cycles among East Asian countries will become much closer due to sector-specific shocks, although inter-industry trade and intra-industry trade lead business cycles across trading countries to move in opposite directions. We define East Asia to include nine emerging economies (China (Mainland), Hong Kong, Taiwan, Singapore, South Korea, the Philippines, Thailand, Malaysia, Indonesia and, one industrial economy (Japan) and India (due to its impressive growth rate). The criteria for selecting this set were data availability and the uncertainty of these countries in other studies as major representatives of Asian emerging economies.