In pairs of countries with stronger trade integration, the growth is more in sync. And this synchronization has to do more with the number of types of intermediate goods traded between the countries, rather than the volume of each good traded. In other words, the breadth plays a bigger role than the depth.
Consider two countries that trade with each other. One country has a rise in productivity, which leads to an increase in domestic output and income. In turn, this leads to importing more intermediate goods—or man-made goods used to produce other goods—from its trading partner, which leads to an increase in the trading partner’s output. Thus, their business cycles become synchronized.
Economist Ana Maria Santacreu of the St. Louis Fed examined this synchronization in a recent Economic Synopses essay. She reviewed a paper she wrote with Wei Liao of the Hong Kong Institute for Monetary Research, which aimed to see what drives this synchronization.1 In their study, the authors segmented the volumes of trade between two countries into two areas:
The authors found that both factors led to business cycles becoming more synchronized.
The authors also found that the extensive margin explained most of the trade-output comovement. The intensive margin played a marginal role. In her Economic Synopses essay, Santacreu explained that shocks have a bigger effect on business cycles between countries when countries produce more differentiated intermediate goods. For example, a positive productivity shock might mean new firms join one country’s domestic economy. This would lead to new products to produce and export to the country’s trading partners.
1 Liao, Wei; and Santacreu, Ana Maria. “The Trade Comovement Puzzle and the Margins of International Trade,” Journal of International Economics, July 2015, Vol. 96, No. 2, pp. 266-88.