Trade restrictions with imported intermediate inputs: when does the trade balance improve?

Abstract

Our model demonstrates that when imports are predominantly intermediate inputs, as in most developing countries, import restrictions cannot be always relied on to generate an improvement in the trade balance. Such restrictions act as a supply shock to the economy. Unless non-traded goods are particularly intensive in imported intermediates, the general-equilibrium consequence of import restrictions is a large enough reduction in export supply to swamp the direct effect of the restrictions, thus leading to a deterioration of the trade balance. The effect of a temporary tariff on imported inputs can be separated into two components, namely, an output composition effect and a real income effect. While the former is ambiguous, depending on the Rybczynki relationship between intermediate imports and non-tradeables, the latter always points toward a deterioration of the current account in the short run.