Impact of Trade Imbalances on Domestic Trade Policy: Does Multilateral Trade Policy Matter?

Abstract

It has been well demonstrated in the empirical literature that trade policy liberalization influences trade performance. 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 imbalances on domestic trade policy liberalization, including in the context of multilateral trade policy liberalization. This analysis is particularly relevant because countries are currently having appetite for trade protectionist measures, which could ultimately undermine multilateral trade liberalization, 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.