Global imbalances in an age of industrial policy
Cesa-Bianchi et al., in this paper, examine why do global imbalances persist and whether industrial policy make them worse.
The authors combine historical analysis, theoretical modelling and empirical estimation for which they use historical current-account data spanning 1870–2024 with a cross-country empirical study of industrial policy covering 2002–2019. The latest assessment of global imbalances refers to 2024. They then focus on industrial policy through three complementary exercises:
- A new text-based measure derived from positive references to subsidies, grants and concessionary finance in corporate earnings calls.
- A two-country heterogeneous-firm model examining how entry incentives, production subsidies and export support affect competitiveness and the current account.
- Regressions that add the industrial-policy measure, and its interactions with capital controls, foreign-exchange reserves and exchange-rate regimes, to the IMF’s external-balance framework.
Findings
- Persistent global imbalances remain primarily the product of domestic macroeconomic fundamentals and policies, rather than industrial policy alone.
- Industrial policy has no significant unconditional association with current-account balances, but it can reinforce surpluses when combined with policies that suppress domestic consumption or prevent exchange-rate appreciation, particularly capital controls, reserve accumulation and managed exchange rates.
- The effects also depend on the instrument used: lower business-entry costs can weaken the current account, whereas production subsidies and export incentives tend to strengthen it.
- Over the longer term, if surplus countries combine industrial policy with measures that restrain domestic consumption, they may expand their tradable sectors at the expense of deficit countries, drawing away production and innovation and weakening productivity abroad.
Rethinking global imbalances: drivers, risks, and policy priorities
Authors: Ambrogio Cesa-Bianchi, Dan Christen, Peter Denton, Aydan Dogan, Will Dison, Ida Hjortsoe, Mark Joy, Jeremy Martin, Daniel Ostry, Roger Vicquery, Simon Whitaker
From: Bank of England
Can tariffs fix trade deficits? The hidden role of global balance sheets
If global imbalances originate mainly in domestic saving and investment, as Cesa-Bianchi et al. argue in the paper above, can tariffs nevertheless correct them through their effects on exchange rates and international balance sheets? This is the question Oleg Itskhoki and Dmitry Mukhin analyze in this paper.
The authors develop a two-country Armington trade model incorporating gross cross-border holdings of bonds, equity, foreign direct investment and other financial claims. They use an intertemporal budget constraint to show that tariffs can change a long-run trade deficit only by revaluing existing external positions or changing future excess returns on the international portfolio. They then:
- Derive welfare-maximizing tariffs using a primal sufficient-statistics approach.
- Examine unilateral tariffs, export taxes and subsidies, retaliation, fiscal revenues and manufacturing employment.
- Extend the framework to a dynamic portfolio model incorporating the United States’ “exorbitant privilege.”
- Calibrate the model to US trade flows and external asset and liability positions.
Findings
An import tariff appreciates the real exchange rate, increasing the value of domestic assets held by foreigners. This produces a wealth transfer abroad, improves the long-run trade balance, but reduces domestic welfare and lowers the optimal tariff.
In the US calibration:
- Closing a permanent trade deficit of 2% of GDP requires an import tariff of approximately 64% and a dollar appreciation of around 22%.
- That deficit-closing tariff reduces permanent US consumption by approximately 1.6%.
- Accounting for US external liabilities lowers the welfare-maximizing tariff from approximately 35% under financial autarky to 9%.
- Tariffs also encourage retrenchment from cross-border portfolios, partially eroding the United States’ exorbitant privilege.
The authors therefore distinguish sharply between a tariff that closes the trade deficit and one that maximizes national welfare. A deficit-closing tariff can be far larger than the optimal tariff and can leave the country worse off.
The Optimal Macro Tariff
Authors: Oleg Itskhoki, Dmitry Mukhin
From: Harvard University, LSE
