Trade Integration and Business Cycle Synchronization

Author:Kevin Cheng - Romain Duval - Dulani Seneviratne

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... (see full summary)

September 2014
Trade Integration and Business
Cycle Synchronization:
A Reappraisal with Focus on Asia
Kevin Cheng, Romain Duval, and Dulani Seneviratne
Over the past two decad es, trade integration has increased
rapidly within the world economy and tight supply chain
networks have been formed , particularly within Asia. Have
these developments st rengthened the propagation of shock s,
and more broadly the synchronization of bu siness cycles
between economies? Base d on a unique dataset, we provi de a
new answer to this old que stion: increased trade integration
in value-added ter ms does increase the synchronization of
growth cycles between e conomies, while gross trade linkages
do not seem to matter. This ef fect appears to be stronger in
crisis times . A related finding is that g rowing dependence of
economies, espec ially within Asia, on Chines e final demand
in value-added ter ms is amplifying the international spill-
overs of growth shocks in Chin a.
e relationship between trade i ntegration and busi-
ness cycle synchroniz ation is theoretically ambiguous and
is therefore mainly an empir ical question. Earlier research
impact, but more recent studies have questioned the va lidity
of earlier results, which h ad not accounted for xed country-
pair factors and common globa l shocks, and thereby may
not necessarily have identie d a causal relationship. Con-
trolling for these omit ted factors, recent papers (such as
Kalemli-Ozc an and others 2013 and Abiad and others 2013)
nd the relationship between g ross trade integration and
business cycle synchroni zation to be insignicant.
In our work (Duval and others 2014), we reassess this
relationship by computing trade intensity i n value-added
rather than gros s terms, building on the recent joint OECD-
WTOinitiativeontrad einvalueadded.Ourlog icisthat
gross trade data mi srepresent trade linkages across countries
amid increasingly i mportant supply-chain networks across
the globe. Value-added trade nets out bilatera l trade in
intermediate goods—un like gross trade data, which count
products multiple times when they c ross borders repeatedly
for processing purposes—a nd thus captures more accurately
the value added embodied i n bilateral trade. Furthermore,
value-added trade includes i ndirect trade linkages v ia third
countries—such as va lue added exported indirectly by
country A to countr y B via intermediate inputs exported by
A to C that are then used to produce a good ex ported by C
to B. Using value-added trade data i nstead proves crucial
to identifying a robus t impact of trade on business cycle
synchron ization.
Stylized Facts About Business Cycle
Synchronization and Trade Integration
Consistent with fi ndings from other simi lar studies, we
find that business c ycle synchronization sharply increases
in crisis times . The largest spikes occurred around the
global fina ncial crisis outside Asia, and around the Asian
crisisofthe late1990swit hinAsia. However,evenduring
normal times, busi ness cycle synchronization—while much
smaller—also shows a n upward trend around the globe
since the 1990s, especi ally in Asia (Figure 1, left).
Turning to trade integration, the most f requently featured
trade variable in t he literature is bilateral trade intensity, for
which we follow the standard de nition (the ratio of the sum
of exports between a cou ntry-pair to the sum of their GDPs),
except that we dene it in a value-adde d sense. Measured
this way, trade openness appears to have inc reased until the
mid-2000s, and more so with in Asia than elsewhere (Figure
1, ri ght).
Vertical trade has als o increased more in Asia than
elsewhere, with Chi na playing a pivotal role. e share of
foreign value-added embedded in tota l exports has gener-
ally increased i n Asian economies, particula rly in East Asia
reecting the “Chi na supply-chain” network. By contras t,
value-addedto/fromJapanhasgeneral lydeclined.Fur-
thermore, the nature of integr ation with partners diers
between China and Japa n, with China specializ ing compara-
tively more in downstream act ivities (such as assembling,
even though China is now increa singly moving up the value
chain) and Japan special izing in upstream activit ies (provid-
ing various intermed iate goods as inputs). Finally, although
the United States and the Europea n Union remain by far
the largest na l consumers of Asia’s supply chain products,
(continued on page 15)

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