The Trade and FDI Effects of EMU Enlargement
33 Pages Posted: 18 Oct 2007
Date Written: October 2007
This paper considers the nature and the distribution of trade and FDI effects of a potential enlargement of the European Monetary Union (EMU) to the ten countries that obtained EU membership in 2004. One-way and two-way error component gravity models are estimated using a dataset of unbalanced panel data that combines bilateral trade flows among 29 countries and the distribution of outward FDI stocks among these countries. The results reveal a complementarity between trade and investment and a relationship between trade and exchange rate volatility that depends on the sign of bilateral trade balances. Using a simulation-based technique, we find that estimates of FDI effects of EMU range between 18.5 percent for Poland and 30 percent for Hungary.
Keywords: EMU, exchange rate volatility, foreign investment, trade diversion, vertical integration
JEL Classification: C33, F21, F31, F33, F36
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