The European Union and the Euro : A Gravity Approach on Bilateral Trade

In the year of 1999 a new monetary experiment commenced – the birth of the euro. Over the years more countries have joined the new currency and it was expected to be a continuously growing community. The purpose of this paper is to measure the effect of European membership, the currency of euro and the financial crisis on trade between the countries located in Europe. For the task of this paper the gravity model is used to study the bilateral trade flows in the European Union from 1995-2011. It additionally investigates, besides the correlation between GDP and distance, the effect of shared border, shared language and coastal access. The results showed that the euro did indeed have a positive impact on trade in the introduction year to later significantly have a negative impact on trade. Moreover, a membership in the European Union results showed to promote intra-European Union trade at the cost of extra-European Union trade and have its largest impact in the beginning and end of the study years. The conclusion is that other factors than increased trade were the main reasons to join the European Union, such as enhancing the role of Europe in the world market and to turn into a unified market. Finally, the effect of the financial crisis was found to have a negative impact on trade, concluded that it exposed the failures and lack of coordination between and within countries. It was also shown that the physical distance, and not specifically distances in i.e. social culture and languages, boosted the trade between countries