The Direct and Indirect Effects of Financial Development on International Trade: Evidence from the CEEC-6

Guglielmo Maria Caporale,Robert Sova,Anamaria Diana Sova

doi:10.2139/ssrn.3703463

Abstract

This paper analyses the relationship between international trade and financial development in six EU members from Central and Eastern Europe (CEEC-6) using dynamic panel data approaches, specifically the system Generalized Method of Moments (GMM) and pooled mean group (PMG) estimators. The empirical results indicate that financial development affects trade flows and the structure of international trade in the long run; more precisely, it has a positive long-run impact on exports and trade openness. Further, there are indirect long-run effects through the interaction terms between financial development and sectoral value added; these are more pronounced for manufacturing than for agriculture. On the whole, our analysis suggests that the CEEC-6 could benefit in terms of trade from further developing their financial systems.

Highlights

After the fall of their communist regimes the Central and Eastern European countries (CEECs) underwent a transition process with the introduction of free market reforms throughout the economy, including the finance and trade sectors
Western Europe soon became one of their most important trade partners. This trade reorientation led to the signing of association agreements with the European Union (EU); this was the first step towards integration, and was soon followed by EU and WTO membership, both of which resulted in a significant increase in trade volumes for the CEECs
The present study examines the linkages between financial development and international trade in six EU members from Central and Eastern Europe (CEEC-6) using dynamic panel data approaches, the system Generalized Method of Moments (GMM) and pooled mean group (PMG) estimators

Summary

Introduction

After the fall of their communist regimes the Central and Eastern European countries (CEECs) underwent a transition process with the introduction of free market reforms throughout the economy, including the finance and trade sectors. The present study examines the linkages between financial development and international trade in six EU members from Central and Eastern Europe (CEEC-6) using dynamic panel data approaches, the system Generalized Method of Moments (GMM) and pooled mean group (PMG) estimators. It analyses the impact of financial development on the two components of trade (exports and imports), and on the trade balance and trade openness. Whilst the existing literature typically focuses on other developed or developing economies, this paper provides evidence for a homogeneous group of six countries from Central and Eastern Europe (CEEC-6) with similar macroeconomic indicators and levels of financial development (see Figures 1-4 in the Appendix). The layout of the paper is as follows: Section 2 provides a brief review of the literature on the finance- trade nexus; Section 3 outlines the econometric framework used for the analysis; Section 4 describes the data and presents the empirical results; Section 5 offers some concluding remarks

Literature Review

Econometric Methodology

Findings

Conclusions