Trade and business cycle synchronization: The role of common trade partners

Abstract

The effect of international trade on business cycle co-movement has traditionally been tested by focusing on bilateral trade relationships. This article studies whether trade also helps synchronize business cycles through a different channel: common export destinations. A simultaneous equations approach is used to disentangle the relationships between business cycle co-movement, bilateral trade, common export destinations and specialization. The results indicate that the business cycles of countries that export to the same third countries are more synchronized, even after controlling for their bilateral trade relationship and specialization patterns. Bilateral trade intensity increases co-movement directly, by facilitating the transmission of shocks, and indirectly, by making production structures more similar. Differences in specialization have a direct negative effect on co-movement due to industry-specific shocks and an indirect one due to lower intra-industry trade. This article also examines and compares the effect that exogenous determinants of trade, such as close geographical distance and common language, have on co-movement via the two trade channels.