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The Trade Comovement Puzzle and the Margins of International Trade

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  • Ana Santacreu

    (INSEAD)

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    Abstract

    Countries that trade more with each other tend to have more correlated business cycles. Yet, traditional international business cycle models predict a much weaker link between trade and business cycle comovement. We propose that the international diffusion of technology through trade in varieties may be driving the observed comovement by increasing the correlation of total factor productivity (TFP). Our hypothesis is that business cycles should be more correlated between countries that trade a wider variety of goods. We find empirical support for this hypothesis. After decomposing trade into its extensive and intensive margins, we find that the extensive margin explains most of the trade–TFP and trade–output comovement. This result is striking because the extensive margin accounts for only a third of total trade. We then develop a three-country model of technology innovation and international diffusion through trade, in which TFP correlation increases with trade in varieties. A numerical exercise shows that the proposed mechanism increases business cycle synchronization relative to traditional models. Impulse responses to a TFP shock in one country reveal a strong positive effect on the output of its trading partner. Finally, our model implies a trade–output coefficient that is 40% of that observed in the data and 5 times higher than that predicted by standard models.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 34.

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    Date of creation: 2012
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    Handle: RePEc:red:sed012:34

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    1. Andrei A. Levchenko & Julian di Giovanni, 2009. "Putting the Parts together," IMF Working Papers 09/181, International Monetary Fund.
    2. Costas Arkolakis & Ananth Ramanarayanan, 2008. "Vertical specialization and international business cycle synchronization," Globalization and Monetary Policy Institute Working Paper 21, Federal Reserve Bank of Dallas.
    3. Comin, Diego & Loayza, Norman & Pasha, Farooq & Serven, Luis, 2009. "Medium-term business cycles in developing countries," Policy Research Working Paper Series 5146, The World Bank.
    4. Timothy J. Kehoe & Kim J. Ruhl, 2006. "How Important is the New Goods Margin in International Trade?," 2006 Meeting Papers 733, Society for Economic Dynamics.
    5. Dutt, Pushan & Mihov, Ilian & Van Zandt, Timothy, 2011. "Does WTO Matter for the Extensive and the Intensive Margins of Trade?," CEPR Discussion Papers 8293, C.E.P.R. Discussion Papers.
    6. Diego Comin & Mark Gertler & Ana Maria Santacreu, 2009. "Technology Innovation and Diffusion as Sources of Output and Asset Price Fluctuations," Harvard Business School Working Papers 09-134, Harvard Business School.
    7. Julian di Giovanni & Andrei A. Levchenko, 2010. "Putting the Parts Together: Trade, Vertical Linkages, and Business Cycle Comovement," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 95-124, April.
    8. Santacreu, Ana Maria, 2011. "Innovation, Diffusion, and Trade: Theory and Measurement," MPRA Paper 35311, University Library of Munich, Germany.
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