International Linkages and the Business Cycle: Lessons from Micro for Macro.

• Author: Levchenko, Andrei A.

The international business cycle exhibits two prominent features. The first is significant positive comovement among countries. Figure 1 illustrates this by plotting the GDP growth rates for the G-7 countries. The tendency of GDP growth rates to move together is evident. Second, country pairs that are more closely linked through trade in goods and multinational production exhibit greater comovement. Figure 2 illustrates this with a scatterplot of the GDP correlation and the bilateral trade intensity for a sample of country pairs.

While the empirical literature has documented these relationships in the aggregate data, the reasons behind them are not well understood. There are two open questions. First, to what extent are these regularities due to transmission of shocks across countries, rather than simply correlated shocks? Second, what types of shocks--technology shocks or demand shocks--drive international comovement?

My collaborators and I take a fresh look at the international business cycle using recent insights from macroeconomics and newly available datasets. A central premise of our research program is that measuring and modeling shocks at the micro level (to firms and sectors) is essential for understanding the macro consequences of globalization. Our ultimate goal is to provide a unified perspective on business cycle comovement at the micro and aggregate levels.

Transmission vs. Common Shocks

In our first project on this topic, Julian di Giovanni and I explore the trade-comovement relationship at the industry, rather than aggregate, level. (1) Industry-level data have two main advantages for studying comovement.

First, sector-country-pair panel data permit the inclusion of set country pair fixed effects to control for aggregate common shocks that plague the interpretation of estimates based on cross-country data. As a result, our approach provides much more robust evidence on transmission of shocks.

Second, sector-level data permit a more precise measurement of input linkages. We use input-output matrices to gauge the intensity with which individual sectors use each other as sources of intermediate inputs in production. We then investigate whether input linkages across industries can help explain the impact of international trade on comovement. This provides evidence on transmission through a particular channel: the use of intermediate inputs in production.

Our main finding is that vertical linkages are an important driver of the trade-comovement relationship: Bilateral international trade increases comovement significantly more in cross-border industry pairs that use each other as sources of intermediate inputs. Our estimates imply that these vertical production linkages account for some 30 percent of the total impact of bilateral trade on the business cycle correlation.

Di Giovanni, Isabelle Mejean, and I then go to the firm level to better understand the role of international linkages in comovement. (2) We use data covering the universe of French firm-level value-added...