A Difference-in-Differences (DID) Analysis of Financial Integration and International Trade in ASEAN+5

As economies progressively integrate globally, the financial structures of markets and the world of finance changes. One of the definitions of financial globalization is integration of domestic financial system of a country with the global financial markets and institutions. It is now accepted that international financial integration allows the optimizing of inter-temporal consumption path and managing of financial risks by increasing the availability of assets in the local markets. It also has the spillover effect of increasing competition and efficiency throughout the international trade. There are different arguments on the impact of financial globalization on the world trade relations, however the empirical evidence is still scarce. This paper tries to fill this gap partially by studying the effects of financial integration on the trade structure operating in the country members of ASEAN+5. The focus on mutual trade relations of the block is of interest, because some arguments suggest that the trade flows extend with globalization, while others predict limitations in financial integration make trade costly at least in the short-term. It is evident that cross-country financial flows to the emerging market economies were low, at during the mid-1970s. They increased at a healthy clip during the decades of 1980s and 1990s, peaking in 1997. They suffered a sharp decline after that because of the “Asian financial and economic crises”. Therefore, the actual impact of financial integration on trade patterns remains an empirical question, which is the main subject of this paper. We analyze whether financial integration contributes to international trade across countries. The analysis focuses on before and after Asian crisis, as a proxy for financial integration, in 1997. We examine how financial integration in both Asian pre-crisis and post-crisis affects the rate of trade flows in the block. To explore this effect on trade, we rely on a dynamic analysis and use a “difference-in-differences” (DID) approach which compares the trade flows among the ASEAN+5 members before and after 1997 Asian crisis. Overall, the results obtained conclude that financial integration makes trade diversion among the ASEAN+5 members.