Ethnic Diversity and International Trade

Ethnic diversity is defined as the variety of different ethnic groups within a society. Conflicts can be caused by more and diverse nationalities within a country although it can also, amongst others, enhance international trade through two channels. First, boosting imports, immigrants demand some of their home-country products. Second, immigrants decrease the transactions costs with respect to uncertainty and incomplete information, which in turn increases exports. It is referred to as migrants possessing superior foreign-market-intelligence, which nationals do not own, therefore engaging in market creation; being able to open up to other markets abroad. Several ways are accessible to measure ethnic diversity, where the fractionalization and polarization index are considered to be close proxies. In this study a polarization index is created as a measure for ethnic diversity, dividing the population by foreign countries they were born and the depth of cleavage being proxied by the six cultural dimensions of Hofstede. This study aims to investigate whether ethnic diversity affects international trade using panel data from 2000 to 2017 of the 28 member countries of the EU. The results show the relationship to be positive, implying ethnic diversity to increase international trade, dominated by the foreign good demand channel over the market creation effect. This study contributes to the existing literature for making it possible to perform a panel data study including fixed effect, when calculating the yearly values for ethnic diversity instead of time invariant values. Moreover, it is the first empirical study to analyze the impact of ethnic diversity on the aggregate of international trade.