An investigation of the effect of the European currency union (euro) on sectoral trade: an application of the gravity model of trade.
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The introduction of the single currency (Euro) in Europe has been referred to as the ‘world’s largest economic experiment’ and has led to major research on the effects of the adoption of a common currency on economic activity with considerable emphasis on its effect on trade flows at the macroeconomic level. However, the investigation of the euro effect on individual sectors has received very little attention and this provides the motivation for the research. The main contribution of this thesis is to the sectoral analysis of the single currency’s effect on bi-lateral trade flows, specifically the effects on the transport equipment manufacturing sector. In order to achieve this, a comparison of the different estimation methods applied in the gravity model literature will be employed to investigate this effect and to identify the factors affecting trade in this sector. This study uses a panel data set which comprises the most recent information on bilateral trade for the EU15 countries from 1990 to 2008. This research aims to build on the results obtained in previous studies by employing a more refined empirical methodology and associated tests. The purpose of the tests is to ensure that the euro’s effect on trade is isolated from the other pro- trade policies of the European integration processes, particularly the introduction of the Single Market. The desirable feature of this approach is that, while other studies limit their attention to a particular issue (zero trade flow, time trend, sectoral analysis, cross-correlation, etc.), very few, if any, apply a selection of techniques. Overall, the results demonstrate that the single currency’s effect on trade in this sector is limited with only the fixed effects formulation with year dummy variables showing a significant positive effect of the euro. An obvious policy implication for countries looking to adopt a single currency is that they should be cautious regarding the potential for growth in intra-bloc trade in a particular sector, although they will benefit from the on-going process of integration.