External Imbalances and Trade Policy

External Imbalances and Trade Policy Stephen Tokarick Adjunct Professor of Economics Johns Hopkins School of Advanced International Studies

Disclaimer • The views expressed in this presentation are those of the author alone and do not necessarily reflect the views of any of the institutions he is affiliated with.

External Imbalances • A number of countries have recorded large external imbalances, current account deficits. These are mainly large industrial countries.

The 2018 IMF External Sector Report notes: • Global external current account balances were about 3 ½ percent of global GDP and about 40-50 percent of these are considered excessive!

• From a global perspective, excess surpluses have been especially large and persistent in a small group of countries, most prominently in Germany and China, and to a lesser extent, in Korea, Netherlands, Sweden and Singapore.

Excess deficits remain mainly in the United States and the United Kingdom, some euro area debtor countries, and a few vulnerable emerging market and developing economies (e.g. Argentina, Turkey).

External Imbalances • Some believe that one way to reduce these imbalances—especially in the deficit countries—is to resort to barriers to international trade.

• Maybe get foreigners to bear the burden of adjustment by raising the price of imports.

• Here in the US, some point to the trade imbalance with China and believe something needs to be done to correct it. There is a perception that trade barriers (e.g. import tariffs) will do the trick.

• What I would like to do in these remarks is to express how a trade economist might view this issue of external imbalances.

Trade Policy to Reduce External Imbalances Do restrictions on imports reduce external imbalances?

Probably not. Here is why: • It is true that tariffs will raise the prices of imports. So this should reduce the volume of imports and improve a trade or current account deficit.

• However, the current account may not improve mainly because a tariff will cause the currency to appreciate and reduce exports.

• Trade economists often mention the “Lerner symmetry” theorem, which says that a tax on imports (e.g. a tariff) is equivalent in its effects to a tax on exports. In other words, a tax on imports discourages exports.

Trade Policy to Reduce External Imbalances Lerner symmetry: Why does this work?

Because a tariff on imports has the SAME effect on relative prices as a tax on exports. ∗ đ?‘ƒđ?‘‹ đ?‘ƒđ?‘‹ Relative prices with a tariff on imports: ∗ (1+đ?‘Ą ) đ?‘ƒđ?‘€ đ?‘ƒđ?‘€ đ?‘€

=

đ?‘ƒđ?‘‹ Relative prices with a tax on exports: đ?‘ƒđ?‘€

=

∗ đ?‘ƒđ?‘‹ ∗ (1+đ?‘Ą ) đ?‘ƒđ?‘€ đ?‘‹

Since with a tax on exports, the relationship between the domestic price đ?‘ƒđ?‘‹ and the international price (đ?‘ƒđ?‘‹âˆ— ) is given by:

đ?‘ƒđ?‘‹ (1 + đ?‘Ąđ?‘‹ ) = đ?‘ƒđ?‘‹âˆ— When the two tax rates are the same đ?‘Ąđ?‘€ = đ?‘Ąđ?‘‹ , relative prices will be the same!

Trade Policy to Reduce External Imbalances • So a 10 percent tariff on imports will have the same effect on relative prices as a 10 percent tax on exports.

• The relevance of this result is: trying to improve the current account deficit through a tariff will be ineffective to some extent because the tariff reduces exports!

• As I noted earlier, a tariff on imports will affect the exchange rate: • For flexible ER: currency will appreciate • For fixed ER: the price of home (nontraded) goods will rise, which is a real appreciation.

Trade Policy to Reduce External Imbalances • The above result is a “general equilibrium” effect: a tariff on imports will cause output of import-competing sectors to rise and draw resources away from other sectors—export and nontraded sectors.

• Plus, exporters may use imported intermediate inputs in the production of exports. So with higher import tariffs, exporters would face higher costs of production.

• All of this suggests that a tax on imports is a tax on exports!

Trade Policy to Reduce External Imbalances Trade economists are fond of saying that external imbalances are a macroeconomic phenomenon.

• Therefore, external imbalances are best addressed through macro policy (fiscal and monetary policy) rather than through trade policy.

• As we know from out national income accounting: • Current account balance = Domestic saving – investment • That is, the external current account balance equals the difference between domestic saving and investment.

Trade Policy to Reduce External Imbalances • Unless a tariff affects saving and/or investment, tariffs (and other kinds of trade restrictions) are unlikely to have a perceptible effect on the current account.

• This has not stopped politicians—and others—from trying to use instruments of trade policy to affect external balances.

What Does the WTO Say? • WTO agreements allow countries to use trade restrictions for “Balance of Payments” reasons.

• The rules governing the use of trade policy instruments for this purpose are laid out in Article XII, Article XVIII:B, and Article XII of the GATS (General Agreement on Trade in Services).

General Provisions: • 1. Article XII can be invoked by all WTO members. Can use trade restrictions to “safeguard the member’s external financial position and its balance of payments.”

What Does the WTO Say? General Provisions: • 2. Article XVIIIB: Can be invoked by developing country members. Can use trade restrictions “needed to safeguard the member’s external financial position and ensure a level of reserves adequate for the implementation of its program of economic development.”

• 3. Agreement asks countries to announce their decision publically.

What Does the WTO Say? General Provisions: • 4. Use price-based trade restrictions (e.g. tariffs) rather than quantitative restrictions (QRs), because price-based measures are more transparent. If the country uses QRs, they need to explain why price-based measures are not adequate. • 5. Measures should be temporary; apply to all imports (rather than specific sectors); and should not exceed the amount of protection needed to correct the external imbalance. Country must also consult with BOP Committee.

How Have Things Worked?

Not many countries avail themselves of the provisions in WTO agreements that allow trade restrictions for BOP reasons.

• Seemed to be more popular under the GATT, rather than WTO. • Most recent cases: Ecuador (2015-2017) and Ukraine (2015).

Ecuador • Imposed import surcharges on imports in March 2015 to address BOP situation which was weakened by the drop in oil prices in late 2014.

How Have Things Worked? Case of Ecuador • The surcharges ranged from between 5 and 45 percent and covered about 31 percent of total imports.

• Due to earthquake in April 2016, it extended the surcharges until June 2017, when they were removed. Ecuador stated that it hoped to expand trade through regional trade agreements.

• Ecuador felt it had to take this action because, in part, the economy is highly dollarized and could not rely fully on monetary and financial policies to address the BOP situation.

How Have Things Worked? Case of Ecuador The Committee on the Balance of Payments at the WTO was somewhat divided on Ecuador’s decision to use trade barriers to address its situation. Some of the issues raised were: • The surcharges did not apply to all imports.

• The Committee on BOP noted that Ecuador had not built up a significant buffer of reserves when oil prices were high. It noted that Ecuador spent the reserves accumulated in boom times on public expenditure.

• How do you measure the BOP shortfall in a dollarized economy?

How Have Things Worked? Case of Ecuador • Some WTO members thought perhaps that Ecuador could try other measures (e.g. fiscal measures) before resorting to trade restrictions.

Others disagreed.

• Some members questioned Ecuador’s exclusion of imports from Paraguay and Bolivia from temporary tariffs.

• A short time after implementation, Ecuador reported that imports fell noticeably. However, one member of the Committee claimed that the BOP position actually deteriorated six months after the imposition of the surcharges.

How Have Things Worked? Case of Ecuador • At the meeting with the Committee on BOP in late 2016, Ecuador stated: “Thanks to the measures adopted and primarily to the balance-ofpayments safeguard, in the period January to September 2016, a trade balance surplus of US$976 million had been recorded, in contrast to the US$1,713 million deficit posted in the same period of 2015. The non-oil trade balance had gone from a US$4,116 million deficit (4.1% of GDP) in the period January-September 2015, to a deficit of US$1,112 million (1.1% of GDP), in the same period in 2016. The lower deficit had been the result of a 30% decline in imports during the period (to US$11,184 million), while exports had fallen by 14.6% over the same period.”

• This reduction in imports could be due to the slowdown in growth, rather than the trade measures. Real growth was 0.1% in 2015 and -1.2% in 2016.

Summary • 1. Ecuador—and other dollarized economies—do not have scope for engineering a depreciation of the currency. So countries in this situation face a challenge as to how to correct BOP deficits. Fiscal policy?

• 2. WTO rules allow countries to use trade restrictions to reduce external imbalances. But the economics suggests that these restrictions will have little if any impact on a country’s external position. Higher tariffs on imports will “tax” exports through several channels, including through paying more for imported intermediate inputs used by a country’s export sector.

Summary • 3. Other options for reducing external imbalances include: (i) some combination of raising saving and/or reducing spending; (ii) depreciation if applicable; and (iii) taxing capital inflows, as suggested

by Freund (2017). This would make borrowing more expensive. • 4. Trade barriers will NOT be effective in reducing a trade deficit unless they alter saving and/or investment. Plus, trade barriers generate deadweight loss. Why do countries want this option?

Maybe allows them a way to raise revenue?

Summary • Theory and Evidence shows that trade barriers have little if any effect on a country’s trade balance. Gagnon (2017) has estimated the determinants of the current account balance in G-20 countries and finds that the impact of tariffs is not statistically significant. • So, if trade restrictions are not a viable alternative to reducing external imbalances, what to do?