Job market paper: The Effects of Trade Costs and Capital Controls on Trade Imbalances  (Job Market Paper)


This paper evaluates the effects of lowering costs of both international trade flows and capital flows on global trade imbalances. I develop a multi-country general equilibrium trade model in which trade imbalances are endogenously determined. The model features both trade costs and capital controls. The latter are introduced as a tax on interest income from bonds. Declines in trade costs and capital controls contribute to larger imbalances by propagating the impacts of fundamental shocks such as productivity shocks that generate trade imbalances. I calibrate the model to 25 countries by exploiting data on bilateral trade flows, aggregate prices, net exports  and measures of capital controls. I conduct counterfactual exercises where I fix trade costs or capital controls at the 1970's level. The results show that the decline in trade costs accounts for 42 percent of the trade imbalances that occurred between 1970 and 2007, while the decline in capital controls explains 22 percent of the imbalances. I also find the effects are heterogeneous across countries. Finally, my model suggests that welfare implications from lowering trade costs and capital controls are quite different. A reduction in trade costs leads to positive welfare gains, but a decrease in capital controls does not necessarily bring positive welfare gains.

Empirical Investigation on the Relationship between Trade Imbalances, Trade Costs and Capital Controls


This paper addresses the empirical relationship between trade imbalances, trade costs and capital controls. In particular, the model in my job market paper predicts that lower trade costs and capital controls amplify the effects of fundamental shocks on trade imbalances. Productivity shocks, for example, are the main driving force of trade imbalances and the effects are bigger if trade costs and capital controls are relatively low compared to the case where trade costs and capital controls are high. I test this propagation mechanism by taking three empirical approaches including a panel regression, a 2-country dynamic regression and a 2-country vector autoregression (VAR). Panel regression shows that changes in net exports respond negatively to productivity growth, and the decrease in capital controls makes this effect more negative. The model's implication for the propagation role of trade costs, however, is not supported by this approach. In the 2-country dynamic regression, trade costs and capital controls amplify the effects of productivity growth on trade imbalances in some countries, but not in others. Finally, the 2-country VAR(1) does not provide the evidence consistent with the model's implication. In sum, there is mixed evidence on the propagation mechanism of trade costs and capital controls.