Impact of trade, industrial dissimilarity, and FDI on the business cycle synchronisation of eurozone economies: Evidences from EC3SLS panel data technique

This paper uses simultaneous equationserror component three-stage least squares (EC3SLS) panel data technique to find out both the direct as well as the indirect impact of trade, industrial dissimilarity and FDI on the business cycle synchronisation of eurozone economies. The period of analysis is 1990 to 2009. The estimated results reveal that trade, industrial dissimilarity and FDI have both direct and indirect effect on the business cycle synchronization of sample economies. While the reported EC3SLS estimates show that closer trade ties among these eurozone countries have led to more synchronised business cycle comovements because common disturbances are more prevalent and intra-industry trade dominates; the bilateral FDI flows have served as a source of disturbance rather than a source of synchronization. Also, trade intensity and FDI flows are positively and significantly correlated, thereby suggesting that more FDI encourages more trade and vice-versa. That is, trade and FDI complement each other. Besides, trade shows a positive relationship with industrial dissimilarity which implies that countries with different industrial structures will enjoy an abundance of inter-industry trade. However, the small magnitude of industrial dissimilarity coefficient in the trade equation suggests that trade-induced specialization has but a weak effect on cycles synchronisation. In addition, the results confirm the presence of intra-industry tradepattern, which was expected in the case of these highly integrated eurozone economies. Thus, the reported results favour the New Trade theory over the Heckscher-Ohlin theory.The upshot of the entire analysis is that these eurozone economies have replaced vertical trade with vertical FDI flows. By generating intra-industry trade, they are currently following New Trade theory, but have diversified production processes even at higher income levels.