Optimal Trade Policy with Trade Imbalances

By Mostafa Beshkar (Indiana University at Bloomington) and Ali Shourideh (Carnegie Mellon University)

A salient feature of international trade is the presence of trade imbalances. How should governments conduct their trade policy under trade imbalances? In a forthcoming paper we ask if trade imbalances influence governments’ choices of trade policies under a standard dynamic trade model.[1] This analysis could shed light on the policy debates in recent years where a widening trade deficit has prompted calls for protectionist policies in the United States and other countries with major levels of trade deficit.


We use a dynamic economic model to study the potential impact of fluctuations in trade volumes and trade deficits on the unilaterally-optimal choice of trade and capital control policies—namely, policies that maximize a measure of welfare of the home country disregarding their effects on the rest of the world.

By using a dynamic framework in which international lending and borrowing—and hence trade imbalances—may occur endogenously, our analysis departs from most of the trade policy literature that focuses on static models with the assumption of balanced trade or an exogenously-given trade deficit.

Using a dynamic—as opposed to static—framework has several advantages for policy analysis. First, it allows researchers to study the relationship between economic fluctuations and trade policy. The vast literature on trade policy—which has concerned itself mostly with static impacts of trade policy—cannot properly address this relationship.

A second advantage of a dynamic framework for trade policy analysis is the ability that it affords researchers to study the potential interdependence between trade and capital control policies. This potential policy interdependence may have important implications for the design and benefits of trade agreements. For example, while trade agreements such as the WTO restrict trade policies, they leave exchange and capital controls to the discretion of the member governments. Therefore, following negotiated trade liberalizations, governments may have an incentive to use exchange and capital controls more actively to affect trade flows to their advantage. It is notable that shortly after its accession to the World Trade Organization, China was frequently accused of manipulating its exchange rate to affect the flow of goods and services.

The use of a dynamic framework is also advantageous for quantitative analysis of trade policy as it could match observed trade flows that involve substantial trade imbalances. The balanced-trade assumption in the previous literature poses a problem for quantitative analysis as it violates the observed trade data. The static trade literature has so far dealt with this problem in one of two ways. The first approach is to introduce aggregate trade imbalances as constant nominal transfers into the budget constraints. The second approach is to “purge” the data from imbalances, namely, conducting the analysis under the counterfactual in which trade is balanced.[2]  A dynamic approach, however, provides a more satisfactory solution by allowing trade imbalances to occur endogenously


A key determinant of optimal trade and capital control policy in a given period is the productivity of the home country relative to the rest of the world in that period. The time variation in these policies, however, depend critically on the set of policy instruments that are employed by the government.

An important case is one in which trade taxes are the only policy instruments at the government’s disposal—i.e., there are no capital control taxes. Under this scenario, there is significant variation in optimal trade policy over time.  In particular, in the absence of capital control taxes, the optimal level of import restriction and export promotion—namely, import taxes and export subsidies—is counter-cyclical.

The counter-cyclicality of import tariffs and export subsidies reflects the government’s desire to improve the country’s intertemporal terms of trade.  That is, individual households ignore their collective effect on the world interest rate and, thus, save and lend too much in booms and borrow too much in downturns, which negatively affects the interest rate for domestic households. To correct for this “inefficiency,” the government’s optimal policy response would be to decrease the price of consumption in high-productivity periods relative to low-productivity periods. This objective may be achieved by applying lower import tariffs together with higher export subsidies in low-productivity periods.

Figure 1 Panel A

Figure 1 Panel B

Figure 1 depicts the optimal level of import and export taxes that we calculate in our paper, for the United States for each year from 1995 to 2016. As can be seen in this figure, over this time period optimal tariffs vary between 27% and 33%, and export subsidies vary between zero and 6%. Nevertheless, if capital controls are used in lieu of export subsidies, the time-variation of import tariffs is virtually eliminated—with tariffs hovering around 25% for the entire period.

The gradual increase in trade protection in the first-half of the time period in Figure 1 reflects an optimizing government’s motivation to discourage borrowing by households from the rest of the world during this relatively fast growth period. Conversely, the gradual decline in the optimal level of protection after 2003 reflects the government’s desire to encourage domestic consumption in lieu of lending to the rest of the world.

Despite the significant time-variation in import taxes and export subsidies that is depicted in Figure 1, the total level of trade protection, measured by the product of import and export taxes, namely, (1+import tax)*(1+export tax), remains relatively constant (around 25%) for the entire time period. In other words, the desired relative price of domestic and imported goods may be implemented using a 25% import tariff alone. Nevertheless, to induce the desired interest rate—or, equivalently, the desired relative price of aggregate consumption across periods—both tax instruments are necessary. This observation suggests that the famous Lerner Symmetry Theorem should be interpreted cautiously in practice.

Remaining Questions

Given the insights we have discussed above, an interesting question that could be addressed in future research is whether capital controls could serve a useful purpose as a flexibility mechanism in trade agreements. Flexibility may be a desirable feature for trade agreements for at least two reasons. First, if political economy preferences are subject to shocks in the future governments will negotiate an agreement that includes a mechanism for policy flexibility such as the WTO Agreement on Safeguards.[3] Second, if trade agreements must be self-enforcing, flexibility in capital control policies could reduce the governments’ incentive to renege on the agreement at times when a surge in imports or a widening trade deficit increases temptations to leave an international agreement.[4]

The possibility of time variation in trade policy is also important in understanding the potential relationship between the state of the economy and optimal trade policy. This is particularly so in order to understand the pattern of optimal trade taxes over the business cycle and the potential relationship between the growth rate of the economy and the optimal conduct of trade policy.  Our model offers a tractable framework in which to explore these issues.


In conclusion, it is worth noting that although the magnitude of changes in optimal tariffs are significant, the quantitative analysis suggests that the gains from this variation are small. In particular, a constant tariff can achieve almost all of the gains from implementing the optimal policy. This finding also implies that under our framework, the negative externality of optimal capital control taxes on the rest of the world is very small.

These quantitative results, however, should be taken with a grain of salt as they hinge on various simplifying assumptions, including the assumption that labor is the only factor of production and no investment in physical capital takes place. Enriching the model by allowing for the possibility of physical capital formation could potentially magnify the welfare effects of capital control policies.


Bagwell, K., and R. Staiger, (1990); “A Theory of Managed Trade.American Economic Review, 80(4): 779-795.

Maggi, G., and R. Staiger (2011); “The Role of Dispute Settlement Procedures in International Trade Agreements.” The Quarterly Journal of Economics, 126, (1): 475-515.

Beshkar, M., and E. Bond, (2017); “Cap and Escape in Trade Agreements.” American Economic Journal – Microeconomics. 9(4): 171–202.

Beshkar, M., and A. Shourideh, (2020); “Optimal Trade Policy with Trade Imbalances.” Journal of Monetary Economics.

Ossa, R. (2016); “Quantitative Models of Commercial Policy.” Published in K. Bagwell and R. Staiger (eds) Handbook of Commercial Policy. Amsterdam, Elsevier.


[1] Beshkar and Shourideh (2020).

[2] See Ossa (2016).

[3] See Maggi and Staiger (2011), Beshkar (2010), and Beshkar and Bond (2017) among others.

[4] The logic here is similar to that of Bagwell and Staiger (1990).



Welcome New Members November/December 2019

We would like to welcome the following new members to the InsTED network

Prof Xue Bai (Brock University). Her research interests are in international trade, industrial organization, economic development and applied microeconomics.

Prof Giovanni Maggi (Yale University). His research interests are in international trade and political economy.

Prof Adeel Malik (University of Oxford). His research interests are in new institutional economics; political economy of Muslim societies and the politics of the private sector in the Middle East.

Prof Hâle Utar (Grinnell College). Her research interests are in international trade and applied microeconomics.

Prof Maurizio Zanardi (Lancaster University).  His research interests are in international trade and political economy.

Welcome New Members March 2019

We would like to welcome the following new member to the InsTED Network

Prof Julian Jamison (University of Exeter Business School)  His research focuses on the interaction between individual preferences, decisions, and well-being on the one hand, and institutional policies on the other.  Much of it has been carried out in more than a dozen countries, especially sub-Saharan Africa.

Prof John Whalley (University of Western Ontario). His research interests lie in the areas of general equilibrium, international trade, public finance, taxes, China and the Asian economies, and environmental economics with a focus on climate change.

Welcome New Members January 2019

We would like to welcome the following new member to the InsTED Network

Prof Emmanuel Milet (Geneva School of Economics and Management).  His research interests lie in the fields of international trade, servitization of manufacturing firms, and ‘trade and labor’.

Prof Monika Mrázová (Geneva School of Economics and Management). Her research interests lie in the fields of International Trade, Political Economy and Industrial Organization.

Prof Marcelo Olarreaga (Geneva School of Economics and Management).  His research interests are in the fields of economic development and international trade.


Global Political Economy Network Conference: Economies and firms in an age of global uncertainty

The Global Political Economy Network Conference is a new two-day academic event aimed at researchers in international economics, political economy, development economics and international business, as well as at policymakers.

Organised by the School of Business and Economics’s TRANSIT research interest group and Economics discipline groupDr Huw Edwards and Dr Ahmad Ahmad are leading on the development of this event as an annual conference.


The GPEN Conference is expected to be of medium size, aimed at researchers in international economics, political economy, development economics and international business, as well as at policymakers. We have given a fairly broad theme of “An Age Of Uncertainty”, but we are interested in papers from all aspects of international political economy. In particular, we would hope to see papers on:

  • International trade policy and agreements
  • Multinational firms
  • Macroeconomic effects of international policy shocks
  • Policy development and practice

Papers from both experienced researchers and from PhD and early career researchers are welcome. We expect to accept a high proportion of submissions.

Keynote Speakers for the main conference

Journal symposium/special issues

  • To be announced

Special Policy Roundtable: Commercial diplomacy and the promotion of trade

Invited panellists include Huub Ruel, University of Twente; Jan Van Hove, KBC bank and KU Leuven; Richard Given, Department for International Trade. Others to be confirmed.

Submission of Papers

Titles and extended abstracts are to be submitted via conferencemaker

  • Closing deadline for submission: Wednesday, 20 Feb
  • Applicants notified by Friday, 1 March
  • Submission of final papers: Friday, 15 March


  • Regular delegate tickets – £150 per person
  • PhD candidates – Reduced fee of £50 upon approval of student status
  • Registration deadline: Friday, 15 March

To Register

Key dates

Conference: 8 – 9 April (Monday – Tuesday)

Closing deadline for submission: Wednesday, 20 February

Applicants notified by Friday, 1 March

Registration deadline and submission of final papers: Friday, 15 March

X RIDGE Forum: Workshop on Poverty and Inequality

The Research Institute for Development, Growth and Economics (RIDGE) and the LACEA Network on Inequality and Poverty (NIP) are pleased to announce a call for papers for the RIDGE Workshop on “Poverty and Inequality”, to be held on 22-23 May in Medellin, Colombia.

Paper submission
Full papers, written in English, must be submitted for consideration for the workshop. The cover page should include: the title of the paper, institutional affiliation, including address, phone and email of each author and an abstract with the appropriate JEL classification. Each author can submit and present at most one paper per workshop (submission of papers to other workshops is possible).

Full papers, in PDF format, should be submitted via the website:
Important dates:

Deadline for paper submission: March 15, 2019 (12 AM ET)
Notification of organizers decision: April 1, 2019
Should you have any questions please contact:

For more information about RIDGE see:

Call for Paper Proposals: 25 Years since TRIPS Patent Policy and International Business

A Special Issue to be published in the Journal of International Business Policy 
Intellectual Property Rights (IPRs) have become ubiquitous in the current debates about trade and gloablization and have emerged as a key issue of contention in global trade and investment negotiations. The ‘Trade Related Aspects of Intellectual Property Rights’ (TRIPS) Agreement, signed in 1994 as a founding element of the World Trade Organization, represents the most important attempt to establish a global harmonization of Intellectual Property protection, creating international standards for the protection of patents, copyrights, trademarks and design. It also provides a dispute settlement schema and establishes enforcement procedures at the intergovernmental level.

Nearly two and a half decades after the TRIPS agreements, much has changed in the global innovation landscape. Technology trade has flourished and more technology has been transferred to emerging market subsidiaries by MNEs.  China has emerged as a major power making huge strides in patenting in both domestic, European and US jurisdictions (Hu et al 2017; Li 2012).  Indian public research institutes like CSIR have found patenting has helped them become more self-reliant for funds.  New institutional forms of Intellectual property which pool patents have also emerged in response to the global challenges.

The special issue aims at stimulating a wider discussion on the international patenting landscape, its use by emerging markets and the influence on trade and MNE strategies.

We welcome proposals addressing these IPR issues and others from researchers in international business, economics, political science, sociology, law, geography, innovation, development studies, public policy, and international relations.

December 15, 2018: Deadline for submission of extended proposals
January 20, 2019:  Notification of acceptance or rejection of proposals for development as  full manuscripts for submission
July 15, 2019: Deadline for submission of full papers via Manuscript Central portal for JIBP  (https://mc.manuscriptcentral.com/jibp)
Jan 15, 2020: Editorial notification of conditional acceptance or rejection for inclusion in the  JIBP special issue
March 1, 2020: Final manuscripts submitted for the special issue

(When) Do Anti-poverty Programs Reduce Violence? India’s Rural Employment Guarantee and Maoist Conflict

Aditya Dasgupta (University of California, Merced), Kishore Gawande (University of Texas, Austin), and Devesh Kapur (Johns Hopkins University – SAIS)

More than half of all nations have experienced a violent civil conflict since 1960.[1] One of the best predictors of conflict outbreak in a country is a low level of economic development and whether it has experienced a civil conflict in the past, suggesting the existence of “conflict trap” in which poverty and violence reinforce one another over time. This begs the question: how do nations break out of the vicious cycle of poverty and violence?

Poverty encourages participation in armed civil conflict in at least two ways. First, it creates economic and political grievances among impoverished groups, providing fertile ground for rebel groups to draw support from those who feel neglected by the state. Second, a lack of employment opportunities and stable livelihoods reduces the opportunity costs of participating in violent conflict, making it easier for rebel groups to recruit fighters.

If poverty fuels violence, then anti-poverty programs ought to play an important role in pacifying violent civil conflict. A large and growing scholarly literature has examined this policy implication, coming to surprisingly mixed conclusions. One randomized study of Afghanistan’s largest development program finds that the program contributed to a modest reduction in violence.[2] Another important randomized study in Liberia found that a combination of cash payments and therapy produced a durable reduction of participation in crime and violence among at-risk young men.[3] Other studies, especially those that examine the roll-out of large-scale government programs and not pilot experiments, have found that foreign aid and development programs are sometimes associated with increases in violence.[4]

How do we reconcile the conflicting evidence, especially the disjuncture between micro-level randomized studies by researchers and the program evaluation literature? We argue that state capacity, or the bureaucratic capacity of a government to successfully implement programs, may play an important role in actuating the pacifying effects of anti-poverty programs. In conditions of low state capacity, program funds are unlikely to pass through to local populations and corruption may even reinforce local grievances with the state and provide opportunities for rebel financing. When local state capacity is strong, however, antipoverty programs have a better chance of actually reducing poverty, improving perceptions of the state, and dis-incentivizing participation in deadly conflict.

To examine this hypothesis, we empirically examine how the roll-out of India’s National Rural Employment Guarantee Scheme (NREGS), a large-scale anti-poverty program which guarantees every rural household in India up to 100 days of public works employment, affected the intensity of the Maoist conflict, a protracted conflict between a Maoist insurgency concentrated in eastern India and the Indian government. Because the roll-out of NREGS was staggered in three phases between 2006 and 2008, we can employ a difference in differences research design. If NREGS reduced violence, we should observe a reduction in violence in districts adopting the program relative to districts experiencing no change in their program adoption status. Moreover, if these pacifying effects depended on state capacity, we should observe that these effects are mainly concentrated in districts with a high level of state capacity, which varies quite substantially across regions and districts of India.

To measure the intensity of the Maoist conflict, we assemble a new panel dataset of violent incidents and deaths at the district level, drawing on the archives of local language newspapers, which ensures that we get adequate temporal and spatial coverage of a long-simmering conflict that occurs mainly in rural areas; existing datasets that draw exclusively on English language sources are heavily biased toward more recent conflict events and those that are close to urban areas. To measure district-level state capacity, we average the ranking of districts across four indicators of basic service provision according to the 2001 census based on the share of villages with: (1) a paved road; (2) a primary school; (3) a primary health center; and (4) an agricultural credit cooperative (the lowest tier of the Indian government’s agricultural credit network).

Using these data, we come to two main findings. First, overall the adoption of NREGS was associated with a large reduction violent incidents and deaths, especially over the long run. To provide a back-of-the-envelope calculation of the size of the pacifying effects, consider the total levels of violence observed in 2008: 619 violent incidents resulting in 751 deaths. According to our regression estimates, counter-factually without the adoption of NREGS across districts, levels of total violence would have been 1,440 violent incidents resulting in 2,030 deaths suggesting that the program eliminated roughly 821 potential violent incidents and 1,279 casualties across districts in that year.

Second, these effects were concentrated in districts with high levels of state capacity. Our analysis of heterogeneous effects suggests that the violence-reducing effects of NREGS were concentrated almost entirely in the top two quartiles of districts in terms of state capacity. In the districts in the bottom two quartiles of state capacity, the program had essentially no impact on violence at all.

What conclusions do we draw? First, NREGS has probably played an important role in the long-term pacification of the Maoist conflict in India. Second, one reason for the mixed evidence from the program evaluation literature on the impact of development programs on violence is that the pacifying effects of anti-poverty programs depend heavily on state capacity, which can vary considerably across and within countries. Indeed, other recent studies have come to similar conclusions – that development programs can reduce violence, but primarily in areas where the state possesses a monopoly of violence and has the capacity to carry out its developmental activities without rebel subversion.[5]

To reduce violence, therefore, policymakers need to encourage not only development through anti-poverty programs, but also the strengthening of bureaucratic and state capacity.


Beath, A., F. Christia, and R. Enikolopov, (2013); “Winning Hearts and Minds Through Development: Evidence from a Field Experiment in Afghanistan.” Paper presented at the 110th Annual Meeting of the American Political Science Association, August, Chicago.

Blattman, C., J.C. Jamison, and M. Sheridan, (2017); “Reducing Crime and Violence: Experimental Evidence from Cognitive Behavioral Therapy in Liberia.” American Economic Review 107(4): 1165-1206.

Blattman, C., and E. Miguel, (2010); “Civil war.” Journal of Economic Literature 48(1): 3-57.

Crost, B., J. Felter, and P. Johnston, (2014); “Aid Under Fire: Development Projects and Civil Conflict.” American Economic Review 104(6): 1833-56.

Sexton, R., (2016); “Aid as a Tool Against Insurgency: Evidence from Contested and Controlled Territory in Afghanistan.” American Political Science Review 110(4): 731-749.


[1] Blattman and Miguel (2010).

[2] Beath, Christia, and Enikolopov (2013).

[3] Blattman, Jamison, and Sheridan (2017).

[4] Crost, Felter, and Johnston (2014).

[5] Sexton (2016).


RIDGE Call for Paper: International Macro – 2018 December Forum

The Research Institute for Development, Growth and Economics (RIDGE) and the Banco Central del Uruguay are pleased to announce the call for papers for the Workshop on International Macro to be held in Montevideo, Uruguay, on 6-7 December 2018.

As in previous years, we are looking for papers focusing on issues related to capital flows, monetary and macroprudential policies, exchange rates, international reserve accumulation, sovereign debt, and international spillovers. Papers in other topics of international macroeconomics and macroeconomics are also welcome.

The deadline for submission is August 31, 2018.
The 2018 workshop will take place within the framework of the 2018 RIDGE December Forum along with the following workshops:

  • Financial Stability, December 4-5 (Montevideo, Uruguay)
  • Economic History, December 7-8 (Montevideo, Uruguay)
  • Environmental Economics, December 10-11 (Montevideo, Uruguay)
  • Macroeconomics and Development, December 10-11 (Buenos Aires, Argentina)
  • Growth and Development in Macroeconomics & Trade and Firm Dynamics, December 12 – 14 (Montevideo, Uruguay)

The RIDGE December Forum aims to favor the spread of high quality research in economics by bringing together top researchers working on the frontier of knowledge with local and regional researchers and policymakers. Participants to this workshop are welcome to attend the other workshops.

Paper Submission

Full papers, in PDF format, should be submitted through: http://www.ridge.uy/paper-submission/

Important Dates

Deadline for paper submission: August 31, 2018
Authors of selected papers will be contacted by September 14, 2018
Workshop: December 6-7, 2018


Organizers will make hotel reservations and cover accommodation costs (up to three nights) to speakers.

Further Information

Should you have any questions please visit http://www.ridge.uy/ridge-forums/2018-december-forum/ or email 

For more information about RIDGE see