Impact of trade imbalances on domestic trade policy: Does multilateral trade policy matter?

• Author: Sèna Kimm Gnangnon
• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/rode.12527

REGULAR ARTICLE

Impact of trade imbalances on domestic trade

policy: Does multilateral trade policy matter?

S

ena Kimm Gnangnon

World Trade Organization, Geneva,

Switzerland

Correspondence

S

ena Kimm Gnangnon

World Trade Organization, Development

Division, Rue de Lausanne 154, CH-1211

Geneva 21, Switzerland.

Email: kgnangnon@yahoo.fr

Abstract

It has been well demonstrated in the empirical literature

that trade policy liberalization influences trade perfor-

mance. However, little is known about how trade policy

reacts to trade imbalances. This article aims to address

this question by investigating the impact of trade imbal-

ances on domestic trade policy liberalization, including in

the context of multilateral trade policy liberalization. This

analysis is particularly relevant because countries are cur-

rently having appetite for trade protectionist measures,

which could ultimately undermine multilateral trade liber-

alization, and hurt domestic economies and the world

economy. The analysis has been conducted on a panel

dataset of 166 countries over the period 1998 to 2015.

The take home message of the analysis is twofold: first,

an improvement in trade balance induces greater domestic

trade policy liberalization. However, this impact depends

on countries’development level, as the magnitude of this

positive impact is higher, the higher the countries’level

of development. Second, an improvement in trade balance

leads to greater domestic trade policy liberalization only

if multilateral trade policy liberalization reaches a certain

level.

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INTRODUCTION

Numerous studies have examined empirically the effect of trade liberalization on trade perfor-

mance, including trade balance and found mixed results, probably because of the time-periods,

estimation techniques, data sets, theoretical measures, and trade liberalization measures used in

these studies. Some studies (e.g., Ahmed, 2000; Bleaney, 1999; Ju, Wu, & Zeng, 2010; Santos-

DOI: 10.1111/rode.12527

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Paulino, 2002a) have obtained a positive effect of trade liberalization on exports and others (e.g.,

Bertola & Faini, 1991; Ju et al., 2010; Mah, 1999; Melo & Vogt, 1984; Santos-Paulino, 2002b)

found that trade liberalization generates higher imports. At the same time, other studies (e.g., Ago-

sin, 1991; Greenaway & Sapsford, 1994; Jenkins, 1996; Ratnaike, 2012; Shafaedin, 1994) have

not obtained significant evidence of a positive effect of trade liberalization on export performance.

Several studies (e.g., Bertola & Faini, 1991; Khan & Zahler, 1985; Krueger, 1978; Santos-Paulino,

2004; Santos-Paulino & Thirlwall, 2004; Zakaria, 2014) have also shown that in response to trade

liberalization, imports increase more quickly than exports, thereby leading to transitory trade imbal-

ances. Nonetheless, other studies (e.g., Ju et al., 2010; Ostry & Rose, 1992) have found insignifi-

cant and mixed outcomes regarding the effect of trade liberalization on trade balance. However, to

the best of our knowledge, little attention has been paid to how a country’s domestic trade policy

is influenced by its trade balance situation. Against this background, the current article investigates

the impact of trade imbalances on domestic trade policies. Trade imbalances are measured for a

given country, as the difference between exports (percent GDP) and imports (percent GDP ). It fur-

ther examines whether this impact depends on multilateral trade policy, that is, the extent of access

to the world trade market by the concerned country. Addressing this topic is particularly relevant

because the current world economic environment is characterized by countries’appetite to adopt

trade protectionist measures in order to address many domestic problems, including trade deficits.

Such domestic trade protectionist measures could trigger trade wars and ultimately adversely affect

domestic economies and the world economy. Greater multilateral trade liberalization reflects bett er

cooperation among the members of the World Trade Organization (WTO), and hence almost all

countries in the world. Such a cooperation would not only be beneficial to all countries, including

developing economies, but it could facilitate cooperation on other international matters such as glo-

bal financial and monetary issues, which would in turn contribute to limiting the occurrence of

financial crises that severely affect domestic economies and the world economy. Better cooperation

on trade matters at the multilateral level could also facilitate cooperation on environmental chal-

lenges faced by the world—such as climate change—as well as the mobilization of international

financial resources to help developing countries mitigate and/or address their vulnerability to eco-

nomic and environmental shocks. The importance of multilateral trade liberalization for domestic

economies has been highlighted by some studies, such as Egger, Larch, and Pfaffermay (2004)

and Collie (2011). Egger et al. (2004) have used numerical models to investigate the impact of

multilateral and bilateral trade and investment liberalization on countries’welfare and convergence

in per capita gross domestic product (GDP). They have reported that pure multilateral trade liberal-

ization could be welfare enhancing. Additionally, both pure multilateral trade liberalization, and

bilateral trade and investment liberalization are less likely to promote most effectively convergence

in per capita GDP (that is, catching up of developing economies in terms of per capita GDP) than

multilateral trade and investment liberalization, or pure multilateral investment liberalizati on. Collie

(2011) has used a Cournot duopoly model to explain the paradox that multilateral trade liberaliza-

tion has resulted in increases in both the volume of world trade and the amount of foreign direct

investment (FDI).

While the objective of trade liberalization is primarily to enhance countries’trade performance

including export performance, it is also possible that countries use trade policies in response to

their trade imbalances. Although this subject-matter has been largely discussed in the theoretical

literature of international trade, we are not aware of studies that really address the issue empiri-

cally. The theoretical debate has surrounded the circumstances and the consequences of using trade

policy to reduce trade imbalances, notably in countries with fragile external positions. On the one

hand, some suggest that in the situation of trade deficits, countries use protectionist measures

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