Let Them Export Cake: An Examination of The Role of Economic Freedoms in Fostering Intra-EMU Export Growth

By Paul Jeffries
Clocks and Clouds
2015, Vol. 6 No. 1 | pg. 1/3 |


This paper investigates the relationship between various types of economic freedom and intra-EMU export growth. Export growth is the primary empirical puzzle that this paper seeks to explicate, and is important because the EMU's inception preceded significant current account differentials that can mainly be attributed to changes in exports, as imports remained relatively constant. The independent variables – all types of economic freedom – were chosen in light of Cerny's theory of the "competition state," which highlights the importance of intra-state competition, theorizing that increased economic freedom renders a state more competitive thereby increasing exports (Cerny 2010). Employing standard econometric analysis and using export growth data from Aristotelous' (2006) gravity model along with ten pre-coded variables for types of economic freedom, I find a positive and statistically significant** correlation between Investment Freedom and bilateral intra-EMU export growth. These results suggest that the determinants of bilateral export growth intra-EMU remain multitudinous, while Investment Freedom is one of the most influential among them.


At present, the Greek financial crisis is one of the most polemic subjects in the news. With bailout packages for Greece still being negotiated at the time of this writing, many wonder what the future holds for Greece, particularly with regards to its role in the Eurozone; talk of the infamous "Grexit" abounds (Lilico 2015). Much more than just a national issue, the crisis in Greece has become a case study for the larger discussion of the European economic system. Many point to Greece as a situation that may adumbrate the future for the various economies in Europe (De Grauwe 2010).

To offer a comprehensive explanation of the current state of the European economic system and the recent crisis in Greece would be a Herculean task. Instead, this paper focuses on a small component of the European international political economy – the bilateral trade between nations within the European Monetary Union (EMU), predominantly exports. In an increasingly globalized world, trade is seen as increasingly important to a nation's economic health (Hirst et al. 1992); hence, the normative implications of this research stem in part from the belief that we can learn more about the wellbeing of EMU nations through the lens of trade analysis.

The specific choice of exports as the focal point of this paper stems from the intriguing quandary they propose. While research has unambiguously shown a positive impact of the EMU on intra-EMU imports, the EMU's effect on exports amongst its adherents has been widely divergent, making exports the driving force behind the ever-widening differentials between the current account balances of EMU nations (Belke et al. 2008). Moreover, the adherent nation most in distress as of late – Greece – also struggles the most when it comes to export growth. As it was put in a recent podcast by NPR's Planet Money: "you like Greek yogurt? [It's] probably not made in Greece [anymore]" (NPR 2015). This all begs the question of what has caused these disparities; how can we understand the curious trends in intra-EMU export growth?

To understand export growth trends within the EMU, I will review the topical scholarly literature on effective currency areas and European monetary integration, while drawing on those within the epistemic community. A broad consensus exists in the literature that the overall effect of EMU on the bilateral intra-EMU trade growth of its adherent nations is positive and significant. Furthermore, the literature demonstrates that this positive effect is not universal. Some members experience little trade growth, or even negative growth; hence, I endeavor to better understand the potential causal mechanisms that govern this disparity. What variable(s) best explain the differentiated EMU effects on bilateral country-specific trade growth between the adherent nations of EMU?

Section I: Literature Review

The EMU is, by all accounts, a relatively new entity, but with a nonetheless, rich, complex, and sometimes turbulent history. The EMU is fundamentally a currency union; therefore, it is appropriate to begin this literature review by delving into the scholarly work on currency unions.

Study of currency unions' effects on trade – particularly motivated by the onset of EMU – is far from a nascent field; however, some general trends still characterize the majority of pertinent scholarly writings. Normally, analyses operate at the macro-level, with such scholars (Rose 2000; 2001; Frankel and Rose 2002; Glick and Rose 2002) "focus[ing] almost exclusively on the overall impact currency unions have on trade while paying very little attention to whether there are significant differences across the individual countries involved" (Aristotelous 2006). These scholars and others who have confirmed their modeling (Barr et al. 2003; De Nardis and Vicarelli 2003; Micco et al. 2003) have all demonstrated that "the effect of EMU on bilateral trade between the 12 countries that adopted the Euro as their national currency was positive and statistically significant" (Aristotelous 2006). It is worth noting, however, that while the literature has consistently upheld the EMU's positive effect on trade at the macroscopic level, this positive effect has seen a downwards revisionary trend over time (Aristotelous 2006). Nonetheless, the most recent comprehensive study still shows that half of the econometric calculations "imply that currency union at least triples trade; 90% of [Rose's] estimates imply a trade expansion effect of more than 25%; and almost all are statistically significant" (Rose 2002). In the scholarly literature, this general positive effect of currency unions – specifically the EMU – on trade flows has become known as the "Rose effect" (De Grauwe 2002).

Some scholars have challenged the validity of the "Rose effect" for its econometric soundness (Persson 2001; Nitsch 2001; and Baldwin 2006). However, most scholars – particularly those dedicated to European monetary integration – such as Bun and Klaasen (2002), Micco et al. (2003), De Nardis and Vicarelli (2003), Flam and Nordstrom (2003), and Berger and Nitsch (2006), believe that the "Rose effect" is at the very least positive and sizeable (De Grauwe 2002). That said, 10% of EMU adherents did not see a large trade expansion effect. One must nonetheless wonder: which member-states were these, and why did they differ?

Viewed concomitantly, Rose's econometric study of the overall currency union effect on trade and the more specific studies of the generally positive trade effects spurred by EMU from scholars such as De Nardis and Vicarelli beg the question: if the positive effects of EMU are not universal, what differentiates the trade winners from the trade losers? To answer this question, the level of analysis must be refined from the more macroscopic level of analyzing the EMU as a whole to the country-specific level.

At the writing of this paper, the two studies most often referenced that examine the EMU effects on trade at the state-specific level – exploring the trade effects of EMU on each individual signatory – are Micco et al. (2003) and Aristotelous (2008). Nonetheless, Micco, Stein, and Ordoñez's paper still adopts a more macroscopic focus than Aristotelous', as it focuses on the effect of EMU on trade relationships outside of the union, finding "no evidence of trade diversion. On the contrary, some of [their] results suggest that the euro leads to higher trade not just with other euroland members, but also with the rest of the world" (Micco et al. 2003) While an important contribution to the literature, Ordoñez et al. sacrifice some degree of precision as a result of their widened scope; hence, while the substantive results of Micco et al. confirm those of Aristotelous, one must turn to Aristotelous to see the most specific and extensive research on country-specific trade effects within EMU.

Aristotelous' 2006 paper picks up where Rose left off and where Ordonez et al. began to investigate, endeavoring to understand the effects of EMU on the trade of each adherent. As they are of great importance to this paper, Aristotelous' empirical analysis and specific gravity model will be expounded on later, as one of the variables for this paper's empirical analysis derives from the findings of Aristotelous' model. Aristotelous' main conclusion in this paper (2006) was gleaned from his use of fixed-effects analysis of pooled data. He found that the impact of EMU on trade is positive and statistically significant for Belgium/Luxembourg, Finland, Germany, Ireland, the Netherlands, Portugal and Spain. For Italy, the effect is positive but not statistically significant. For Austria, France and Greece, the effect of EMU on their trade to the euro area is negative and statistically significant (Aristotelous 2006). As one can see, the previous quandary pertaining to the 10% of nations in Rose's most recent study that did not exhibit a positive trade effect because of EMU is now clarified thanks to Aristotelous' modeling; instead, the gap in the literature to explore has now become a question of what differentiates Austria, France, and Greece – whose bilateral intra-EMU exports were negatively affected by EMU – from all of the other EMU adherent nations, who experienced positive effects.

Aristotelous, along with other scholars, can provide us with a variety of theories that might explain this differentiation in EMU effects on exports. As Aristotelous writes, "[F]rom a theoretical perspective, the differentiated effect of EMU on trade may arise because EMU countries differ in terms of trade composition, different level of economic development, different level of integration, or even different degree of trade openness" (Aristotelous 2006). Each of these potential explanations has its merits, but some more so than others.

Trade competition and level of development, while perhaps theoretically promising as intervening variables in the creation of this disparity in EMU trade effects, are not supported by the substantive contributions in the literature. Aristotelous defuses the argument for trade competition as a possible explanatory variable by citing case studies: "Differences in trade composition or level of development cannot be sources for the differentiated EMU effect on trade. EMU had a positive and significant effect on the trade of Portugal and a negative and significant effect on the trade of Greece, two countries with similar trade composition, level of development, and even population" (Aristotelous 2006). This refutation is supported by other scholars, including Vicarelli et al. (2008), who found that even states such as France and Germany that share a dominant sector were affected by the EMU in vastly different ways. Aristotelous defuses the argument for different levels of integration as being a potential explanatory variable again via the case study, stating: "the level of integration could be an explanation for the effect of EMU on Greece's trade since Greece is isolated geographically from the rest of the EU, but this explanation could not be valid for France, a country that is one of the founding members of the EU and is at its geographical [center]" (Aristotelous 2006). Further scholarly work supports Aristotelous' conclusions, highlighting EMU as one of the best case studies to date concerning integration (Ludema et al. 1999).

From here, it seems that of Aristotelous' proposed explanations, all that remains promising is the hypothesis that trade openness can explain the bilateral trade growth differentials. Aristotelous hints that the impact of trade openness has yet to be explored, but shows signs of veridicality: "The most likely source of the EMU differential effect on trade is a country's degree of trade openness. Countries with a higher degree of trade openness (such as Germany) are likely to reap greater benefits from the lower transaction costs, reduced exchange rate uncertainty, and enhanced competition through greater price transparency resulting from the introduction of a common currency" (Aristotelous 2006). While logically and theoretically promising, this assertion has yet to be empirically tested in a substantive manner. This is part of the purpose of this paper.

In a more recent paper, Aristotelous explores Greek exports, demonstrating that "the effect of the EMU on Greece's exports to Eurozone is negative and statistically significant," an astonishing discovery given that one of the primordial purposes for EMU was to increase intra-EMU trade (Aristotelous 2008). Perhaps even more important, however, is Aristotelous' conclusion that the empirical evidence "suggests that the negative EMU effect on Greece's exports to Eurozone is in part due to a loss in Greece's competitiveness in Eurozone markets" (Aristotelous 2008). This finding, suggests that trade competitiveness may be a variable of vital importance in determining the nature of the EMU's effect on a constituent nation's bilateral export growth. Trade competitiveness and the principles of neoclassical economic theory will be explored in greater depth in the forthcoming section on theory with an eye towards better understanding how competitiveness in Eurozone markets informs an EMU nation's trade growth.

As can be seen, a substantive gap in the literature is present, offering a promising research avenue to explore. Aristotelous' first paper, along with the work of Ordoñez et al., has elucidated the disparate trade effects of EMU on its constituent nations, with some suggestion that degree of national trade openness might be responsible for this disparity. It is Aristotelous' concluding call for further research in this area to explore the possibility that trade openness might account for the varying ways in which EMU nations did and did not experience the ‘Rose effect' that this research aims in part to answer. Aristotelous' more recent case study highlights the peculiar case of Greece – a state that experienced a negative effect on export growth because of EMU and also saw its intra-EMU overall exports decrease as a result of joining the Euro, in part due to reduced competitiveness.

Given the widespread consensus in the literature that the EMU has had a macroscopically positive trade effect on its constituent nations but with great diversity in the magnitude of the ‘Rose effect' experienced at the country-specific level, I aim to depart where Aristotelous left off, seeking to explore whether or not evidence exists to substantiate the claim that trade openness – along with other indicators of economic freedom and openness of varying types – might be influential variables in the causation of the EMU's export effect disparity on its adherents.

Section II: Theory

Having established a clear explanation of where this research fits in the context of the aforementioned epistemic communities, the primary theories on the basis of which the forthcoming hypotheses will be posited now merit explanation. The first theory to be examined will elucidate the perspective I adopt when conceptualizing state economies within the EMU, which is one based predominantly on the ‘interstate competition' hypothesis, which derives from one of the basic premises of neoclassical economics.

The most cited work widely considered to be the seminal contribution to the field that deals with the role of inter-state economic competition in an increasingly globalized world is written by Allen Scott. Therein is his now widely accepted claim that globalization is leading not only to an increase in relationships of interconnectedness but also relationships of inter-state competition (Scott 1999). More specially, I find Philip Cerny's argument pertaining to the modern transition from "raison d'État" to "raison du Monde" to be quite persuasive (Cerny 2010). In essence, Cerny elaborates on the competition-based relationships between states that Scott began to develop, believing that Foucault's "Raison d'État is being superseded by a transnationalising, globalizing rationality that [Cerny] call[s] raison du Monde, at the core of which is the imperative of maintaining and promoting competitiveness in a world marketplace and multi-level political system – the Competition State" (Cerny 2010). I am persuaded by the arguments of Scott and Cerny, and find it useful to thus adapt the economic viewpoint of competition theory in contemplating state ambitions; it is widely acknowledged that states are increasingly interconnected, but they are nonetheless still competing against one another.

Adopting this mindset, one can begin to imagine that states, much like producers seeking to make a profit, will attempt to render themselves more competitive. In an increasingly globalized world, competition becomes even fiercer, as international trade is facilitated. As transport costs are reduced, geography can become less of a hindrance to trade; thus, the international market becomes increasingly competitive. The key takeaway from this competition theory approach offered by the likes of Scott and Cerny, and adopted in this paper, is the need to view states as engaged in competition, and increasingly so due to globalization. As such, the question surfaces: how did EMU affect the competitiveness of its adherents?

It merits reiterating that the main historical point of interest in this paper is the difference in national economic competitiveness within the European community prior to EMU as compared to after EMU.1 Beginning with what many would argue is the first major step towards the establishment of EMU – the Maastricht Treaty – economic competition within EMU nations began to change rapidly, as the tools for national differentiation were increasingly limited by the goal of national policy coordination (Grieco 1995). More specifically, many scholars have proven empirically what would seem theoretically obvious: all that EMU entails – from the single market, to the universal elimination and restriction of intra-EMU barriers to trade, to the introduction of the common currency – have had positive general effects on intra-EMU trade (Berger et al. 2008). Phrased in the diction of Cerny's ‘competition state' theory, EMU has made intra-EMU trade more preferable. At the same time; however, EMU served a homogenizing purpose as well, by leveling the competitive economic playing field among EMU nations in many respects. As numerous scholars have illustrated by focusing on specific sectors – for example Pagano, Marco, and Von Thadden (2004) who studied homogenization's effect on the bond markets of EMU's adherents – EMU's resulting policy assimilation amongst its adherents has eliminated many mechanisms that once differentiated the nations of EMU; where once national economic competitiveness was influenced by currency and trade barriers, homogenization has done away with such differences (Pagano et al. 2004).

It is here that the principles of neoclassical economics begin to visibly inform the formation of my forthcoming hypotheses. I find it convincing that by eliminating various mechanisms by which the ‘Competition State' had previously been able to determine its own competiveness as regards international trade, EMU has had a moderating effect on the variables that determine a state's competitiveness (Cerny 2010). By eliminating determinants of relative national economic competitiveness such as currency strength and various trade barriers, other determinants will see their relative importance exacerbated as a result of EMU.

Aristotelous' suggestion that a link may exist between trade openness and intra-EMU bilateral export growth is convincing; however, there are other, more convincing potential explanatory variables. The reason why trade openness alone may not have the most powerful effect on state competitiveness and thus bilateral export growth is that some of the components of trade openness will be controlled by EMU's regulatory bodies or its subsidiary treaties. In other words, some of the determinants of national trade openness will have been substantially homogenized by EMU (Grieco 1995). For example, trade openness is generally constituted of tariffs and non-tariff protectionist measures, such as administrative red tape, quality regulations, etc. As a result of this, a large portion of the policies that constitute trade openness will be homogenized by EMU regulatory bodies. This point can be further clarified drawing from the theoretical work on intrinsic vs. extrinsic incentives for reform by Karagiannis and Konstantinidis (2013).

Karagiannis and Konstantinidis (2013) focus on the issue of intrinsic and extrinsic incentives for reform. I propose that the same lens of analysis can be applied to the labeling of policies, as opposed to incentives. For example, let us return to Aristotelous' trade openness theory. As was discussed, trade openness can be stratified into tariff and non-tariff barriers to trade, the latter not being controlled by the EMU regulatory bodies, while the former is. Given this regulation, regardless of the intrinsic national motivations for tariffs prior to EMU, all adherent states after EMU will have to homogenize their policies, thereby all adopting a similar policy of no tariff barriers to trade intra-EMU – a policy decision that was extrinsically imposed and not necessarily intrinsically motivated. This homogenization will, however, not interfere with states' policies on non-tariff barriers to trade, meaning that greater disparity will exist between the non-tariff protectionist policies of EMU nations, leading to greater differentiation and thus more obvious differences in competitiveness as competition states.

In conclusion, I argue that the scope of promising variables that might explain the disparity in intra-EMU bilateral trade growth must be expanded. Instead of simply trade openness – the effects of which would be in part limited due to the homogenization of the extrinsically regulated components thereof – I propose that all varieties of economic freedom be examined. Out of all of types of economic freedom – from Trade Freedom to Freedom from Corruption – I propose that the variables least affected by extrinsically imposed EMU regulations will correlate with bilateral intra-EMU export growth to a greater extent than those types of freedom that were more greatly affected by EMU regulations. For example, Monetary Freedom will most likely not have as much predictive statistical power in determining a nation's intra-EMU export growth because EMU nations share a currency and thus will have largely homogenized and extrinsically regulated Monetary Freedom. Following the same logic, a variable such as Investment Freedom appears to be quite promising, as the EMU regulatory bodies govern investment to much a lesser extent than they do trade or currency; hence, one would expect greater variations in Investment Freedom amongst the EMU nations and thus a better chance that Investment Freedom will play a significant role in the determination of intra-EMU export growth.

Drawing from neoclassical economics and its many subsidiary theories such as that of the ‘Competition State,' I see a potential explanation for the divergent outwards trade effects of EMU on its adherents begin to emerge: EMU has created a significantly homogenized international economic playing field in which national absolute and comparative trade advantages have less determinants, rendering the remaining determinants more influential. With this theoretical justification having been explained, the hypotheses to be tested are as follows:


  • H1 : As Market Openness increases, so too will weighted intra-EMU export growth.
  • H2 : As Investment Freedom increases, so too will weighted intra-EMU export growth.
  • H3 : As Trade Freedom increases, so too will weighted intra-EMU export growth.
  • H4 : As Financial Freedom increases, so too will weighted intra-EMU export growth.
  • H5 : As Overall Economic Freedom increases, so too will weighted intra-EMU export growth.
  • H6 : As Monetary Freedom increases, so too will weighted intra-EMU export growth.
  • H7 : As Business Freedom increases, so too will weighted intra-EMU export growth.
  • H8 : As Fiscal Freedom increases, so too will weighted intra-EMU export growth.
  • H9 : As Property Freedom increases, so too will weighted intra-EMU export growth.
  • H10 : As Freedom from Corruption increases, so too will weighted intra-EMU export growth.

Each of these hypotheses serves to test the potential relationship between my outcome variable and one of my 10 independent variables. As I will expound, Market Openness is a variable that I codified myself for the purpose of this paper, aggregating the effects of Investment, Trade, and Financial Freedom inspired by the Heritage Foundation's dataset overview. Finally, I expect the correlative strength of the relationships explored in hypotheses pertaining to variables with little extrinsically imposed EMU regulation to be higher than those that are regulated to a greater extent by EMU. Using the same example as previously referenced, I predict that H2 will be one of the most robust out of all of the hypotheses, given the minimal regulatory power exerted by EMU over the investment policies and regulations of each nation.

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