Does dollarization promote trade? Evidence from two recent episodes

We quantify the trade-promotion effects of sharing a common currency by examining two recent episodes of official dollarization. To establish causal relationships, while avoiding the methodological criticisms of the previous literature on the issue (endogeneity and heteroskedasticity), we employ a differences-in-differences strategy that compares the pre- and post-dollarization trade flows between the United States and the two dollarizers (Ecuador and El Salvador) with the trade flows between the United States and the dollarizers’ neighbours. We find that the adoption of the dollar did not bring about any significant positive trade effects. Using product-level data we find that, while a few sectors saw positive increases, those instances are scattered and not the norm. Dollarization did not lead to increases in trade of previously non-traded goods either. Finally, we do not find any trade-promotion effects between Ecuador or El Salvador and the other dollarized country in the region (Panama) or between the newly dollarized countries themselves. These findings remain valid after we perform a battery of robustness tests, including PPML estimation.