What matters for the economic synchronization of the Baltic States

Abstract

Three small Baltic economies of Estonia, Latvia and Lithuania have undergone extreme economical system change from the planned economy to the market one. The institutional infrastructure have been reorganized and all three countries joined the EU and Euro area. We aim to answer which channels of economic integration are of the largest importance for the small open European economies. We showed that all three countries could be treated as one region due to development, institutional and economic similarities. Secondly, we explore whether the trade or common currency is the main channel for the business cycle synchronization across the region of three small Baltic economies. The business cycle synchronization and trade intensity (TI) between the Baltic States and their main trading partners before and after joining the EU have been investigated as an example of an ex-post case for the small economies. We have observed a large increase in TI with the trading partners from EMU and EU countries, irrespective of the TI calculation method. The analysis of business cycle synchronization of the Baltic States with their main trading partners is captured by the correlations of the cyclical component of GDP series, using the quarterly real and de-trended GDP growth data from 1995 Q1 to 2019 Q4. The panel model has indicated an important empirical feature that the common currency strongly and significantly impacted the business cycle synchronization whilst the bilateral trade intensity between the Baltic States and their main trading partners have a significant negative effect on the business cycle synchronization when controlling for time effects. The Granger causality test confirmed that the most robust impulses to the Baltic States are coming from EU trading partners.