Monday, August 7, 2017

Douglas L. Campbell on "Breaking Badly: The Currency Union Effect on Trade"

Douglas Campbell has written a very interesting paper on the effects currency unions have on trade in which the analysis of the data comes to different conclusions than current economic literature.  He explains the paper in his blog post and his concerns that the paper will never be published, because he is going up against big names in the profession.  Basically, his paper tests whether omitted variables in past studies affect the analysis of a large data set.  He looks at each major currency union including the eurozone and appropriate control groups and finds according to the papers abstract: "As several European countries debate entering, or exiting, the Euro, a key policy question is how much currency
unions (CUs) affect trade. Recently, Glick and Rose (2016) confirmed that currency unions increase trade on average by 100%, and that the Euro has increased trade by a still-large 50%. In this paper, we find that the apparent large impact of CUs on trade is driven by other major geopolitical events correlated with CU switches, including communist takeovers, decolonization, warfare, ethnic cleansing episodes, the fall of the Berlin Wall and the whole history of European integration. We find that moving from robust standard errors to multi-way clustered errors alone reduces the t-score of the Euro impact by 75%. Looking at individual CUs, we find that in no cases does the time series evidence support a large trade effect, and that the effect breaks particularly badly once we find suitable control groups. Overall, we find that intuitive controls and omitting the CU switches coterminous with war and missing data render the trade impact of the Euro and all CUs together statistically insignificant."  The paper can be found here.

His conclusion, in his blog post explanation of the paper and the analytical process involved, with respect to the eurozone is not comforting: "Is this research that important in the end? Admittedly, most countries that joined the Euro did not do so based on their belief of the CUs and trade literature. Nevertheless, the Euro has, in my view, been mostly a catastrophe for southern Europe. I believe the first best option for these countries would be more aggressive pro-growth stimulus from the ECB, but, absent that, I think these countries should think seriously about exit. While the Euro is a bit different from most other currency unions (the definition is that two countries have currencies that trade at a 1:1 par value), there is no hard evidence that Euro Area countries will face a trade collapse if they leave the Euro."

If what is taught is more important than intellectual debate which advances thinking, then economics becomes a guild and not a profession.  If one person is arguing data and methodology and another is arguing what they were taught and believe, there can be no communication.

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