International Trade and Comovement of Business Cycles

This paper examines the impact of international trade on business cycle comovement using a unique dataset of sectoral output and trade flows. While the earlier studies employing aggregate data are certainly useful in understanding the broad impact of trade linkages on the transmission of business cycles, they are not helpful in analyzing the mechanisms through which trade flows affect business cycle comovement. This is particularly important considering that the nature of trade linkages has been changing due to the rapid growth of intra-industry (sectoral) trade flows (see Kehoe and Ruhl, 2003). Moreover, the use of sectoral data allows us to test the relevance of certain theoretical predictions and helps improve the design of stochastic dynamic general equilibrium models (see Kose and Yi, 2006; Bergoeing and Kehoe, 2003). For example, if industry-specific shocks are important in driving business cycles, theory predicts that increased intra-industry specialization across countries can increase cyclical comovement, but the degree of comovement might fall if inter-industry trade linkages are spurred. Our findings suggest that the impact of trade on the degree of business cycle comovement is two to three times larger than that estimated in earlier studies using aggregate data. This result is mainly driven by the dominant role played by intra-industry trade flows. In particular, sectors with relatively larger intra-industry trade exhibit a higher degree of comovement across countries. The impact of trade on business cycle comovement is three to four times larger in pairs of developed countries than those of developing ones.