The microeconomic impacts of the euro

Economists sometimes happen to reach conclusions at odds with common sense. Regarding monetary integration, a widely quoted paper suggested very large trade creation effect of adopting a single currency: a common currency would raise trade by 235% (Rose, 2000). Subsequent literature has pointed a series of technical issues blurring these estimates and pointed to at most a 10% trade increase in the case of the euro (Baldwin and Taglioni, 2006). Still, what is more important is to understand why and how trade should increase.

Recent developments related to international trade with heterogeneous firms (Melitz 2003), based on a framework allowing for multi-product firms (Bernard, Redding and Schott, 2006, or Eckel and Neary, 2006), suggest an even richer combination of effects. The macroeconomic view is that firms will export more because adoption of a common currency increases the value of their shipments. This is the intensive margin of exports. But increased price transparency and competition may well reduce the number of competitors. At the same time, reducing the cost of exporting (due to reduced transaction costs or exchange rate volatility) may lead more firms to export because the productivity level necessary to afford bearing those costs is lowered. The next question is how many different products exporters will ship to foreign markets. A euro-led decrease in the variable trade cost will lead to an increase in the number of different products that are delivered by each of fewer exporters. Accordingly, the range of goods produced by each firm and the proportion of goods that are exported will vary in opposite directions. At last, there is the issue of the number of markets to which each individual variety is exported. The numbers of firms, products, and destination markets are the components of the so-called extensive margin of trade.

Identifying microeconomic mechanisms

Testing for the microeconomic mechanisms of the euro’s effects requires highly disaggregated data. Two options may be contemplated here. The first option is to rely on trade data at the product level, as recorded in international trade data statistics, at the most granular level of the classification of traded products. But part of the observed “intensive” margin of exports may be due to additional firms exporting the same products to the same markets in this case. The second option is to rely on individual firms’ export data. This then provides enough information to address the microeconomic effects of the euro: number of firms shipping their goods in a product category, number of product categories in which each firm is actually exporting, and average number of destinations for a given product.

A unique database on French firm-level exports, provided by the French customs, has recently made such a research strategy possible. It has provided a clear description of all adjustments that occur at the firm level within each product category. The data cover the 1998-2003 period. Let’s define, for convenience, a variety as a product category exported by a single firm. Using this data, we (Berthou and Fontagné 2008) build measures of the intensive and extensive margins of French exports. The intensive margin corresponds to the value of exports by variety; the extensive margin corresponds to the number of varieties exported to each destination country or to the number of destination markets per variety exported.

The euro’s effects on French firms

The first striking result is the large concentration of exporters. Only a limited proportion of firms are actually exporting, which is very much in line with the theoretical assumption of heterogeneous firms. Interestingly, the total number of firms exporting towards European markets tends to decrease between 1998 and 2003 (around 1.5% in total). Mergers may explain this as well as changes in the regulations for recording exporters declarations. Still, after controlling for the latter, this reduction in the number of exporters is still present in the data. Since the bulk of exports are shipped by a limited number of exporters, the average number of shipments (the number of products exported a by firm times the number of destinations) is quite large: 18 to 19. The bottom line is that over time, a smaller set of firms is shipping more products at higher values, on average. Hence, the two margins of exports interact. The challenging question is: how did they interact when the euro entered the picture?

Answering that question requires a properly designed counterfactual: what would have been the behaviour of French exporters in the absence of the euro? Comparing the trends described above with changes in French exports to non-euro destinations since 1999 provides some clues. Changes in French firms’ exports to eurozone markets have been driven by the extensive margin (the number of varieties and the number of destinations for each variety within the eurozone) more than by the intensive margin (the value of shipments to each market within the eurozone, by variety). Disentangling the components of the former, the number of exporters has decreased, while the number of products exported by each individual exporter to at least one market within the eurozone has increased on average. On the top of this, the number of destination markets (within the eurozone) for each variety , has also increased. In comparison French exports to markets outside of the eurozone grew along the intensive margin. The difference is striking: more French firms exported a reduced portfolio of products, with higher values per shipment, outside Europe. It is less clear when the comparison is limited to other European markets outside the eurozone. These comparisons are shown in Figure 1. It might be the case that other elements of the European integration have played a role in this case. Baldwin et al. (2008) extend this approach to an outsider (Hungary) and check that such effects were not present for outsiders exporting to the eurozone.

Figure 1. Extensive and intensive margins of French exports: Percent change 1998-2003

Such comparisons only provide incomplete evidence of the microeconomic effects of the euro. An econometric approach is necessary to identify changes due to the euro and changes due to other factors. It is therefore necessary to make use of bilateral trade equations. In our paper, we use appropriate controls for the real exchange rate, foreign demand, bilateral distance, and other geographical variables are driving trade flows and find strong evidence of a positive effect of the euro on the extensive margin of French exports, while no differential effect of the euro is found on the intensive margin. Importantly, these results are robust to the inclusion of a control for nominal exchange rate volatility, meaning that the elimination of nominal exchange rate volatility is not the only factor responsible for the positive effect of the euro that we measure in the data. In other words, the euro had a positive effect on the average number of varieties exported to each eurozone partner but no effect on the average value of exports by variety.

All these findings are consistent with the view that the introduction of the euro contributed to a decrease in trade costs, and especially in the fixed entry cost, thus leading to a positive outcome on the extensive margin (as also suggested by Belgian firm data). In the end, the increase in the extensive margin of French exports to eurozone destinations was driven by increases the number of products exported by firms and the number of destinations for varieties, as the number of firms exporting decreased.

References

Baldwin, R. and Taglioni, D. (2004). Positive oca criteria: Microfoundations for the Rose effect. COE/RES Discussion Paper Series No. 34.

Baldwin, Richard, Virginia DiNino, Lionel Fontagné, Roberto A. De Santis and Daria Taglioni. 2008. "Study on the Impact of the Euro on Trade and Foreign Direct Investment". Economic Papers 321, European Commission Directorate-General for Economic and Financial Affairs.

Bernard, A., Redding, S. and Schott, P. (2006). "Multi-Product Firms and Trade Liberalization," Centre for Economic Performance DP 0769.

Eckel, C. & Neary, J.P., (2006). Multi-Product Firms and Flexible Manufacturing in the Global Economy, CEPR Discussion Paper 5941.

Melitz, M. J. (2003). The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica, 71(6):1695–1725.

Rose, A. K. (2000). One money, one market: the effect of common currencies on trade. Economic Policy, 15(30):7–46.