Ruhr Economic Papers

Ruhr Economic Papers #776

Trade and Capital Flows – Substitutes or Complements? An Empirical Investigation

by Ansgar Belke and Clemens Domnick

UDE, 10/2018, 40 S./p., 8 Euro, ISBN 978-3-86788-904-9 DOI: 10.4419/86788904



This paper examines the linkages between the trade of goods and financial assets. Do
both flows behave as complements (implying a positive correlation) or as substitutes
(negative correlation)? Although a classic topic in international macroeconomics, the
empirical evidence has remained relatively scarce so far, in particular for the Euro area
where trade and financial imbalance played a prominent role in the build-up of the
European sovereign debt crisis. Consequentially, we use a novel dataset, providing
estimates for financial flows and its four main categories for 42 countries and covering
the period from 2002-2012, to test the so-called trade-finance nexus. Since theoretical
models stress that both flows might be influencing each other simultaneously,
we introduce a novel time-varying instrumental variable based on capital control
restrictions to estimate a causal effect. The results of the gravity regressions support
theories that underline the complementarity between exports and capital flows. When
testing the trade-finance nexus for different types of capital flows, the estimated
coefficient is most pronounced for foreign direct investment, in line with theories
stressing informational frictions. Robustness checks in the form of different estimation
methods, alternative proxies for capital flows and sample splits confirm the positive
relationship. Interestingly, the trade-finance nexus does not differ among countries
belonging to the EMU, the European Union or among core and peripheral Euro area

JEL-Classification: F14, F15, F21, F41

Keywords: Capital flows; economic integration; Heckscher-Ohlin paradigm; interaction between trade integration and capital mobility; trade