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July 11, 2019

Trade Balances Mostly Driven by Economic Forces, Not Tariffs


By IMFBlog
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Over the past two decades, most of the changes in bilateral trade balances—the difference in the value of exports and imports between two countries—were explained by macroeconomic factors, according to IMF research.


These factors include fiscal policy, demographics, and weak domestic demand. They may also include exchange rate policies and domestic supply-side policies, like subsidies to state-owned enterprises or to export sectors.

In contrast, changes in tariffs played a much smaller role in influencing trade balances.
Our chart of the week from the April World Economic Outlook quantifies the drivers of changes in bilateral trade balances. It specifically looks at the roles of macroeconomic factors, tariffs, and how countries organize their production (the sectoral composition of countries’ production and demand).



The figure shows the contribution of each of these factors for a few pairs of countries. As you can see, macroeconomic conditions play an important role. For example, macroeconomic factors accounted for about 20 percent of the change in the US-Germany trade balance from 1995 to 2015, and these same factors accounted for over 95 percent of the change in the US-China trade balance.

Most of the changes in bilateral trade balances over the past two decades were explained by macroeconomic factors.

Changes in tariffs played a smaller role, reflecting their already low levels in many countries and the fact that reciprocal tariff reductions had offsetting effects on bilateral trade balances. Imposing a bilateral tariff on a trading partner is also ineffective to address aggregate trade imbalances (that is, the sum of a country’s bilateral trade balances with all its trade partners) because consumers will just switch their demand to other trading partners that face no tariffs.

But this doesn’t mean that tariffs don’t matter. Increases in tariffs would particularly hurt output, jobs, and productivity. And the integrated nature of the current global trade system suggests that a sharp increase in tariffs would also impact other countries, creating a ripple effect from one another and leaving the world economy worse off.

Policymakers should therefore continue to promote free and fair trade by undoing recently enacted tariffs and enhancing efforts to reduce existing barriers to trade. They should also avoid policies that distort the economy, such as governments stimulating the economy with additional spending when demand is already strong or heavily subsidizing exporting sectors, that create excessive—and possibly unsustainable—imbalances.

IMFBlog is a forum for the views of the International Monetary Fund (IMF) staff and officials on pressing economic and policy issues of the day. The IMF, based in Washington D.C., is an organization of 189 countries, working to foster global monetary cooperation and financial stability around the world. The views expressed are those of the author(s) and do not necessarily represent the views of the IMF and its Executive Board. (More by IMFBlog here)   

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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