Chapter 1 General Introduction

General Introduction

1.1 Introduction

This thesis deals with various aspects of International Economics. Within this admittedly very large field, we have chosen to focus on three main themes: (i) the existence of a world business cycle and the implications thereof, (ii) the likelihood of asymmetric shocks in the Euro Zone resulting from fluctuations in the euro exchange rate because of differences in sec- tor specialization patterns and some consequences of such shocks, and (iii) the relationship between trade openness and growth influence of the sector specialization structure on that relationship.

Regarding the approach pursued to tackle these problems, we have chosen to strictly remain within the boundaries of empirical (macro)economics - that is, applied econometrics. Though we will systematically provide theoretical models to back up our empirical approach, our only real concern will be to look at the stories the data can (or cannot) tell us. As to the econometric methodology, we will restrict ourselves to the use of panel data analysis. The large spectrum of techniques available within the panel framework allows us to utilize, for each of the problems at hand, the most suitable approach (or what we think it is).

1.2 Motivations

This thesis, thus, consists in a collection of empirical works about a certain number of issues pertaining to International Economics: international busi-

13

14 CHAPTER 1. GENERAL INTRODUCTION ness cycles, asymmetric shocks in the EMU in relation with the various sector specialization patterns, and the trade and growth relationship in connection with sector specialization concerns. The question is: why bother?

To begin with, the adoption an international point of view arises as an unavoidable requirement for anyone wishing to gain insights on the actual functioning of the world as it stands today. Globalization appears indeed as of the most salient features of our contemporaneous world. According to most observers, the world has become increasingly more open to trade and capital flows since WWII. To cite but a few figures, according to the IMF, world GDP per capita has doubled and world production has quadrupled since 1950. Over the same period, international trade has multiplied 18-fold and FDI has multiplied 25-fold. In 2002, world exports of goods and services amounted to 6270 and 1570 billion USD, respectively ¹ . In comparison, world GDP was estimated, roughly, around 32 000 billion USD ² that same year.

That is, trade flows account for approximately one fourth of world GDP.

This proportion, which is already far from negligible, is likely to continue to rise in the future. Indeed, the dramatic increase in trade and capital flows that took place during the second half of the XXth century can be ascribed to two major causes, none of which should disappear in a near future. First, technical progress has played a non-negligible role, at least in two respects.

On the one hand, it has allowed for a sizable diminution in transportation costs (see, e.g. Hummels (1999) for some evidence). On the other hand, the recent boom in information technologies permits easier and more accurate comparisons across suppliers from all over the world (see, e.g. Cairncross (1997)). In the same vein, Rauch (1999) argues that both the costs of infor- mation about foreign markets and the cost of establishing trade relationships in these markets is an increasing function of distance. These costs are most likely to be reduced with technical progress going on. We cannot figure out any reason why technical progress, or its effects of trade, should suddenly stop in the coming years. The second reason why we think trade and capital flows have increased in the past and are still likely to do so in the future is the the multilateral trade liberalization program started soon after WWII and which is still far from completion. The GATT was created in 1947-1948 and managed to achieve significant reductions in trade barriers through a series of multilateral negotiations round before being replaced by World Trade Or-

1

Source: WTO, International Trade Statistics

2

Source: CEPII, CHELEM Database

ganization (WTO). The WTO, in turn, has already achieved agreements on telecommunication services, financial services, or information technologies.

It has also agreed upon the so-called “Doha Development Agenda”. In clear, the Fourth Ministerial Conference that took place at Doha (Qatar) in 2001 provided WTO representatives with the mandate to negotiate on such top- ics as agriculture, services, implementation issues, etc. Negotiations on the Doha Agenda are still an ongoing issue. Their conclusion should, however, lead to lower trade barriers and increased trade and capital flows.

Within this globalization process, and in the context of regional integra- tion agreements, the EU emerged as a major trading power, accounting for roughly 20% of world trade in goods and services circa 2000. The birth, growth, and maturation of a strong integrated area in Western Europe ap- pears as one of the most salient features of the second half of the XXth Century. The EU is now able to compare to both USA and Japan, whether in terms of size, wealth or even openness. Table 1.1 presents some summary statistics on these three regions for the year 2001. The EU, even before its recent enlargement, was the most populated area. Its total GDP amounted to approximately 80 % of US GDP. In terms of GDP per capita, however, it proved the less wealthy area. These last two figures can, however, be mis- leading. Table 1.1, indeed, presents figures for 2001, a period during which the euro nominal exchange rate was very low. However, even in PPP terms, the EU-15 remains the less wealthy area, though the differential - in partic- ular with respect to Japan - becomes much lower. Finally, as far as external trade flows are concerned, the EU emerges as the most open area.

Let us now explain in more details the structure of this thesis and how it deals with the research program mentioned in Section 1.1. We now describe our methodological framework, which is common to all Chapters and, next, we present a brief description of these Chapters themselves.

1.3 The Approach Pursued

In each Chapter of this thesis, we have tried to follow a common method- ology. As a consequence, our various Chapters all bear a similar structure.

We first always begin with laying the foundations of the problem. That is,

we try and provide some informal economic reasoning and confront it with

the relevant empirical facts or regularities. The next step consists in review-

ing the scientific literature that has flourished around the issues at stake.

16 CHAPTER 1. GENERAL INTRODUCTION Table 1.1: The EU-15, the USA and Japan - Summary Statistics (2001)

EU-15 USA Japan Total GDP

7 934 10 082 4 176 Total Population

379 285 127 GDP per capita

20 935 35 376 32 880 PPP GDP per capita

22 795 31 900 25 027

Openness

22.8 18.6 17.4

Source: CEPII, CHELEM Database and WTO

a

Billion current USD

Million people

Current USD

d

Constant 1995 USD and PPP exchange rates

e

(exports + imports) / GDP, in percent (source: WTO)

As already mentioned, our research in the present work are only concerned with applied econometrics. However, we do not think that applied econo- metrics is synonymous to data mining, quite the contrary. Instead, we share the view according to which empirical models should be, at least to some extend, theory-driven. Therefore, after the review of the literature, we will systematically try and propose a small theoretical structure aimed at justify- ing our empirical approach of the problem under study. From this theoretical structure, we will draw the equations that will be estimated. It must how- ever be understood from the start that this thesis in not about theoretical work whatsoever but merely intends to present applied econometric work.

After discussing data and estimation methods, we turn to the analysis of the results as such. There, as well as in the conclusions, we will systematically put a special emphasis on policy recommendations.

1.4 Outline of the Thesis

As mentioned above, our primary concern is about international macroe-

conomics and the current wave of globalization. In this respect, Chapter 2

investigates the issue of international business cycles. It considers a database

that includes 113 countries for which the dynamics of GDP is observed over

30 years. We apply a novel econometric technique, namely a generalized

dynamic factor model (see Forni et al., 1999), hereafter GDFM, to this

database. This technique allows us to disentangle a common component from an idiosyncratic component in each country’s economic fluctuations.

The common component is defined as the portion of economic fluctuations that is ascribable to world shocks, whereas the idiosyncratic component is the part of fluctuations that is generated by country-specific shocks. One of the main advantages of the GDFM is that it allows for some correlation among idiosyncratic components, which is consistent with basic intuition, rather than imposing orthogonality. To give but an overview of the results, the world shocks explain on average 25% of fluctuations, with marked dif- ferences across countries. This analysis also enables us to study similarity issues across the various countries. We conduct such an analysis on existing regional integration blocks. The European Union (EU-15) emerges as the most integrated group. Estimating a “second-level” GDFM on idiosyncratic components of the EU brings the existence of an European business cycle to light. This cycle explains about one third of total fluctuations in the Union on average. This Chapter gave rise to a publication in the review “Empirical Economics ” (Malek Mansour, 2003).

Chapter 3 digs deeper into the issue of common shocks affecting the var- ious European economies. Specifically, it investigates the impact of fluc- tuations in the euro-dollar exchange rate on the various economies of the Euro Zone. Such shocks are, by nature, common to all countries belonging to the Euro Zone. They may however have asymmetric impacts provided their transmission mechanisms differ across countries. One of the essential components entering the transmission mechanism is the sector specialization pattern. The question we address is thus twofold: (i) is it indeed the case that the structure of sector specialization may induce asymmetric responses to exchange rate fluctuations? and (ii) are there marked differences in sector specialization patterns across countries in Europe ? As to the first question, we show that the degree of competition in a given sector has a significant influence on its reaction to exchange rate fluctuations. The second question also finds a simple answer: there do, indeed, exist important differences in sector specialization patterns across countries in Europe. On the basis of these findings, we assess - from a quantitative point of view - the impacts for the European economy of a 10% depreciation of the euro vis-a-vis the US dollar. Such impacts differ both across countries and across sectors. One part of this Chapter was included in a CEPII’s working paper (Fouquin et al., 2001) and another part is forthcoming in the review “International Finance”

(Sekkat and Malek Mansour, 2005).

18 CHAPTER 1. GENERAL INTRODUCTION Chapter 4 keeps on with investigating the impact of sector specializa- tion, but in a more global context. Indeed, this Chapter tackles development issues and wonders how to generate growth and wealth in a priori poor coun- tries. The dominant paradigm consists in prescribing all-out liberalization policies to these countries, especially regarding their external trade relation- ships. We question such remedies and wonder whether their efficiency might be hampered, or even reversed, due to an inauspicious sector specialization pattern at the time of liberalization. We find that it is indeed the case, both because of demand-side considerations (inadequacy of the specialization pat- tern to the dynamics of world demand) and of supply-side considerations (when initial specialization lies in sector with low productivity growth po- tential). We identify such auspicious and inauspicious sectors by means of an analysis by production stage. It appears that liberalization policies have both positive impacts on these countries specialized in the terminal stages of the value chain, and less positive or even negative impacts on those countries specialized in the initial stages of the value chain.

Finally, Chapter 5 draws the general conclusions from these three essays, with a special emphasis on policy issues.

1.5 REFERENCES

Cairncross, F. (1997), “The Death of Distance: How the Communi- cations Revolution Will Change Our Lives”, Harvard Business School Press, Boston, USA.

Forni, M., Hallin, M., Lippi, M., and Reichlin, L. (1999) “The Generalized Dynamic Factor Model: Identification and Estimation”, CEPR Discussion Paper, no. 2338.

Fouquin, M., Sekkat, Kh., Malek Mansour, J., Mulder, N., and Nayman, L. (2001) “Sector Sensitivity to Exchange Rate Fluc- tuations”, Documents de Travail du CEPII, no. 11, November 2001.

Hummels, D. (1999), “Have Transportation Costs Declined ?”, mimeo, University of Chicago Graduate School of Business.

Malek Mansour, J. (2003), “Do National Business Cycles Have an

International Origin ?”, Empirical Economics, vol. 28, no 3, pp. 223-

247.

Rauch, J.E. (1999), “Networks versus Markets in International Trade”, Journal of International Economics, 48(1), pp. 7-35.

Sekkat, Kh. and Malek Mansour, J. (2005), “Exchange Rate

Fluctuations and Asymmetric Shocks in Europe”, forthcoming in Em-

pirical Finance.