On the Robustness of the Trade-Inducing Effects of Trade Agreements and Currency Unions

Regional trade agreements (RTAs) and currency unions (CUs) share the characteristic of being poten- tially endogenous proxies for trade costs in gravity equations. In both cases, this problem is magnified by the paucity of reliable instruments. Instead of resorting to the oft-employed alternative of panel data to address selection on just the time-invariant unobservables, this paper assesses the extent to which the positive association between CU or RTA membership and bilateral trade can be considered causal. Despite not identifying point estimates, striking results are obtained when looking at overall trade and extensive margins. Although most cross-sections exhibit a positive association between both RTAs and CUs and overall bilateral trade, the evidence in favor of a causal e¤ect is strong only for CUs. Interestingly, for recent years, there exists strong evidence in support of both RTAs and CUs causing trade at the extensive margin. However, the magnitude of either e¤ect is sensitive to the amount of selection on unobservables. Key Words: Regional Trade Agreements, Currency Unions, Gravity Model