Chapter 4: The Drivers of Bilateral Trade and the Spillovers from Tariffs
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International Monetary Fund. Research Dept.
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Abstract

The presence of large and rising bilateral trade balances has raised concerns that asymmetric obstacles to trade may distort the international trade system. This chapter examines the drivers of bilateral trade balances, distinguishing between the roles of macroeconomic factors, the international division of labor, and bilateral tariffs. It also examines how, through their impact on the ways production is organized within and across countries, tariffs affect productivity, output, and employment. Three main findings emerge. First, the evolution of bilateral trade balances since the mid-1990s reflects mostly macroeconomic forces known to determine aggregate trade balances at the country level. Second, changes in bilateral tariffs played a smaller role than macroeconomic conditions in explaining the evolution of bilateral trade balances over the past two decades, reflecting tariffs’ already-low levels in many countries and the fact that reciprocal tariff reductions had offsetting effects on bilateral trade balances. But other policy distortions—such as supply policies—may have played a role. Third, declining tariffs have lifted productivity by allowing greater international division of labor and further specialization by countries, including through participation in global value chains. The integrated nature of the current trade system suggests that a sharp increase in tariffs would create significant spillovers, leaving the global economy worse off. These findings support two main policy conclusions. First, the discussion of external imbalances (of which trade balances are the largest part for most countries) is rightly focused on the macroeconomic factors—for example, fiscal policy—which tend to determine trade and current account balances at the aggregate level. Targeting particular bilateral trade balances will likely only lead to trade diversion and offsetting changes in trade balances with other partners. Second, multilateral reductions in tariffs and other nontariff barriers will benefit trade and, over the longer term, improve macroeconomic outcomes.

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