Trade Effects of Euro Adoption in Central and Mediterranean Europe

This thesis investigates the trade effects of Euro adoption for Cyprus, Malta, the Slovak Republic and Slovenia. These countries are the first out of the ten 2004 EU entrants to give up their sovereign monetary policy in order to join EMU and commit themselves fully to the European ideal. In order to shed light on the theoretical debate on the benefits of a currency union versus the lost control over monetary policy, this thesis inquires into the trade effects brought about by Euro adoption by these new EMU members amidst the financial and European debt crisis. By using a panel of data comprising export data of 36 countries over 12 years (2000-2011) and using the gravity model with country-pair fixed effects with time fixed effects, two sets of hypotheses are tested. The first set inquires into the trade effects per country compared to all other countries in the sample. The results show that all four countries except for Cyprus display an increase in total trade. Evidence of trade creation is found for Slovenia and the Slovak Republic, since both countries showed an increase in trade with countries inside and outside EMU since they adopted the Euro. Cyprus displayed a drop in total trade, which is explained by a severe drop in trade with countries outside EMU, hinting at trade diversion. In the second set of hypotheses the average trade effects of the new EMU members is compared to that of the average of the ten 2004 EU entrants. The results show that the average growth in total trade of the new EMU members has been less than that of the 2004 EU entrants since 2007. When looking at trade with specific trading partners no evidence was found that the new EMU members traded less with existing EMU members, but there is evidence that they traded less with countries outside EMU, compared to the 2004 EU entrants’ average. However, when Cyprus is excluded from both the new EMU members and the 2004 EU entrant group, the new EMU members no longer show a deviating trade pattern compared to the 2004 EU entrant group. This leads to the conclusion that the lost control over monetary policy is, for the given moment, a too costly trade-off given the lacking of any marginal increase in trade compared to the 2004 EU entrants.