Specialization Patterns, GDP Correlations, and External Balances

This article provides evidence of a link between specialization patterns—in intermediate inputs or final goods—and business cycle correlations: countries with a similar intermediate goods content of exports tend to have more correlated gross domestic product fluctuations and external balances. We produce a model that replicates these facts. A productivity shock in a large country (‘the U.S.’) has a smaller effect on the terms of trade of countries that share its specialization, while being shared fully with countries specialized in the other type of good through a terms-of-trade effect. In the presence of complete asset markets, the trade balance reflects the flow of insurance payments. All countries who benefit little from the shock in the large country will have correlated, negative net exports. The trade balances of all other countries will jointly move in the opposite direction.