Exchange controls and international trade

December 19, 2007

Free Market Foundation

Attempts to enforce exchange controls by government to stop companies and individuals trying to circumvent a country’s capital account restrictions raise the cost to firms engaging in importing and exporting, according to a National Bureau of Economic Research (NBER) Working Paper.

Other findings:

Countries tend to have more controls on capital transactions and foreign exchange transactions than on trade payments.

At the same time, countries with more controls in one category are also likely to have more controls in the other categories.

Broadly speaking, all three indices showed a moderate decline during the years 1996-2005 for countries instituting multiple controls.

Further:

An increase by a single standard deviation in the controls on foreign exchange transactions reduces trade by the same amount as an increase in the tariff rate of 11 percentage points.

A comparable increase in the controls on trade payments has the same negative effect on trade as an increase in the tariff rate of 14 percentage points.

The experience of the emerging market economies during the late 1990s suggests that controls on capital transactions that are intended to regulate capital flows also tend to harm trade substantially.

The effects may also interact with other features of the economy; the same exchange controls may do either more or less damage in a governance-challenged economy, depending on whether corruption primarily weakens the exchange controls or exacerbates the burden of complying with the controls.

Source: Matt Nesvisky, Exchange Controls and International Trade, NBER Digest, December 2007; based upon: Shang-Jin Wei and Zhiwei Zhang, Collateral Damage: Exchange Controls and International Trade, Working Paper No. 13020, National Bureau of Economic Research, April 2007.

For text: http://www.nber.org/digest/dec07/w13020.html

For study: http://www.nber.org/papers/w13020

For more on Economic Issues: http://www.ncpa.org/sub/dpd/index.php?Article_Category=17

FMF Policy Bulletin/ 11 December 2007