Question

How much trade do currency unions create?

Answer 1

Currency unions are an important institutional arrangement to facilitate international trade and reduce trade costs. In the period since WWII, a total of 123 countries have been involved in a currency union at some point. By the year 2015, 83 countries continued to be involved in one. In addition, various countries are considering forming new currency unions or to join existing ones. For example, the East African Community is thinking about setting up a common currency. Also, Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, and Sweden are supposed to join the euro at some point.

Today, there are more than twenty official currency unions. The most-used being the euro, which is used by 19 of the 28 members of the European Union; the U.S. dollar, which is the official currency in the U.S., Puerto Rico, El Salvador and many others; and the Swiss franc that is official in Switzerland and Lichtenstein.

The European currency union in its contemporary form can be traced through various economic unification strategies throughout the latter half of the 20th century.
A currency union or monetary union is distinguished from a full-fledged economic and monetary union in that it involves the sharing of a common currency between two or more countries, but without further integration between participating countries. Further integration may include the adoption of a single market in order to facilitate cross-border trade, which entails the elimination of physical and fiscal barriers between countries to free the movement of capital, labor, goods, and services in order to strengthen overall economies.

The intuition is that small import shares are high up on the demand curve where sales are very sensitive to trade cost changes. Large import shares are further down on the demand curve where sales are more buffered. As a result, smaller import shares have a stronger trade cost elasticity in absolute magnitude.