Changes in Bilateral Trade Costs between European Union Member States & Major Trading Partners: An Empirical Analysis from 1989 - 2006

Today, more than 50 years after the Rome Treaty, the EU has made great strides in its’ economic integration and liberalization of movement of goods and people. International trade theory predicts deepening economic integration inside the European Union will increase regional trade and have large effects on agglomeration of industry patterns. In particular, the Core Periphery theory predicts the core of Western Europe and center of economic prosperity will spread economic growth to the periphery through increased integration. Thus, it is hoped that the EU Core, who benefit from their central location and a long history of integration in Western Europe, will increase growth to the periphery through deepening integration and a relative drop in trade costs. Critics cite the Spring 2010 debt crisis in Greece and subsequent shock to Euro zone stability as an indication that EU integration has not been successful. Given increased skepticism of the Euro zone, measuring changes in trade costs between 2001 Euro adopters and the main trading partners provides one quantitative measure to better understand the depth of EU integration in the recent period from 1989‐2006. Using the Novy (2008) model, which measures bilateral trade costs directly from trade flows, the measure includes all trade costs incurred in getting a good to its’ final user, other than the production cost of the good itself. Results show the drop in trade costs over the more recent period 1995‐2006 to be largest for trade between countries who adopt the Euro in 2001 (‐53%). The second largest drop in bilateral trade costs is between 2001 Euro adopters and the Central Eastern European Countries who joined the EU in 2004 (‐49%). The third largest drop in bilateral trade costs is between the 2001 Euro adopters group and the large non‐continental Europe trading partners (‐45%). Large differences in trade costs appear between countries within the 2001 Euro adopters who are considered members of the Core versus those in the Periphery. Over the 1995‐ 2006 period trade costs drop by 24% more for trade within the Core versus Trade between the Core and the Periphery. While the Core‐Periphery theory is slow to be realized in our empirical results of trade costs over the 1995‐2006 period; trade costs among EU members and Euro adopters are relatively large‐ 33‐53%‐ when compared to trade costs measured for the non‐continental European trading partners‐5%. This 7‐11 times larger drop in trade costs for trade intra‐EU and Euro adopter members‐ both original and accession‐ is an empirical testament to the EU’s success at integrating diverse economies within the union.