The macroeconomic effects of trade tariffs: Revisiting the Lerner

symmetry result

This paper discussed the macroeconomic effects of trade policies, particularly focusing on the
proposed border adjustment of corporate income taxes (BAT) in the context of recent U.S. tax
reform proposals. The paper aims to reassess the traditional views on the effects of BAT and
quantify deviations from the Lerner symmetry theorem in a New Keynesian Dynamic Stochastic
General Equilibrium (DSGE) model.
The Lerner symmetry theorem says that if a country imposes a tax on imports and gives the same
amount of money as a subsidy to its exports, it can balance out the effects of the trade policy.
This means that the prices of goods and services won't be distorted, and the economy will stay in
balance without any major changes. It's like a balancing act that keeps things fair and doesn't
disrupt the overall economic situation.

The introduction of import tariffs and export subsidies in a sticky price framework
Two pricing assumptions are commonly used: producer currency pricing (PCP) and local
currency pricing (LCP). PCP assumes that export prices are set in the domestic currency and
adjust one-for-one with changes in the exchange rate. LCP assumes pricing to market, with
pricing and invoicing in the local currency. Changes in custom duties and exchange rates
gradually transmit to the price of imported goods and services under LCP.
The terms of trade measure the ratio of import prices to export prices after subtracting import
tariffs. It shows the relative price of a country's imports compared to its exports. If tariffs have a
minimal impact on prices, an increase in tariffs leads to an improvement in the terms of trade,
while an increase in the exchange rate without a corresponding adjustment in export prices leads
to a decline in the terms of trade.
The trade balance is influenced by the terms of trade. Import tariffs create a gap between import
spending and exporter earnings in the trade balance. The financial implications of customs duties
are reflected in the overall effect on the home economy's primary surplus, which considers the
impact on government revenues and expenses.

The excerpt describes a complex economic model that studies the effects of different shocks on
two countries. The model includes factors like sticky wages and prices, habit persistence,
investment costs, and financial market dynamics. It assumes that the exchange rate is determined
by bond holdings and considers incomplete financial markets.
The model is calibrated to match the trade intensity of the home economy and follows a
monetary policy rule. It presents various scenarios, including changes in import tariffs and export
subsidies. The results show that an increase in import tariffs leads to an appreciation of the home
exchange rate and a decline in real imports. It also affects the terms of trade and leads to a
decrease in output. However, it improves the nominal trade balance. The effects on foreign
countries are relatively small.
On the other hand, an increase in export subsidies has opposite effects, with a less significant
appreciation of the exchange rate. The combined effects of import tariffs and export subsidies
cancel each other out due to the Lerner symmetry, resulting in no significant changes in the
exchange rate or price indexes.
In simpler terms, the model shows that changes in trade policies, such as tariffs and subsidies,
can affect exchange rates, imports, exports, and the overall economy. The specific effects depend
on the type of policy and the interactions between countries. The model provides insights into
how these shocks impact various economic variables.

In Section 5, the authors analyze the macroeconomic costs of a trade war using two
scenarios:
5.1 Retaliation through Import Tariffs: The foreign economy retaliates against the home country's
BAT by imposing import tariffs equal to the sum of the import and export subsidies. Under
complete markets assumption, effects on quantities, prices, and nominal exchange rates are
symmetric. However, the home terms of trade worsen, leading to a permanent deterioration in the
home trade balance. Under incomplete markets assumption, there are asymmetric effects on
output and the terms of trade due to the relative size of tariff increases. The trade war results in
substantial declines in output and trade at the global level.
5.2 Fully Symmetric Response: In this scenario, the foreign economy provides export subsidies
to match the home tariffs, and import tariffs are raised to offset the home export subsidy. This
fully symmetric response nullifies the adverse impact of the trade war, regardless of how
exchange rates are determined. Budgetary implications are of secondary importance when trade
is balanced.
2. FDI and trade—Two-way linkages?

This research paper explores the relationship between foreign direct investment (FDI) and
international trade. It investigates how FDI and different types of trade flows, such as horizontal
and vertical FDI, are connected.
The main findings of this paper on FDI and trade are as follows:

1. The paper identifies two-way feedback effects between FDI and trade. It shows that as FDI
inflows increase, trade volumes also tend to rise. This suggests a positive association between
FDI and international trade.

2. Horizontal FDI refers to a type of foreign direct investment where companies replicate similar
production facilities or plants in different markets. In this case, the objective is to serve the local
market rather than relying on international trade. For example, a company may establish
manufacturing plants in multiple countries to produce and sell its products locally. The findings
of the paper suggest that horizontal FDI tends to substitute trade. This means that when
companies engage in horizontal FDI, they rely less on international trade because they are
producing and selling within the target markets themselves.

On the other hand, vertical FDI involves fragmenting the production process across different
countries. This means that different stages of production, such as research and development,
assembly, or headquarters services, are located in different countries. For instance, a
multinational company may conduct research and development in one country, while outsourcing
manufacturing to another country and distributing the final products globally. The paper indicates
that vertical FDI tends to create trade. This implies that when companies engage in vertical FDI,
it stimulates international trade activities. This is because the fragmented production process
requires coordination and exchange of goods and services across borders.
3. Developing countries that experience improvements in productivity tend to attract more
vertical foreign direct investment (FDI), which leads to increased international trade. Vertical
FDI involves fragmenting the production process across different countries, and when
multinational companies invest in such a manner, it stimulates trade activities. This is because
the fragmented production process requires coordination and exchange of goods and services
across borders.

4. The presence of vertical FDI in developing countries also has an additional effect on the labor
market. It increases the demand for skilled workers in those countries. As a result, the return on
human capital (skills and knowledge) in the developing country rises. This positive impact on
skilled labor creates a feedback loop between FDI, trade, and skilled labor. Essentially, the
increased trade resulting from vertical FDI creates more demand for skilled workers, leading to
higher returns on human capital, and in turn, attracting more FDI.

5. The paper emphasizes the significance of FDI in driving export-led development. It finds a
strong linkage between FDI and trade in goods, indicating that FDI plays a crucial role in
facilitating international trade. However, the paper suggests that other linkages between different
trade and financial accounts are relatively less important in comparison.

6. Through empirical analysis using statistical methods, the paper establishes a substantial
relationship between trade in goods and FDI. It identifies Granger-causality, meaning that
changes in FDI can be observed to precede changes in trade openness, and vice versa. These
findings support the idea that FDI and trade have a mutual relationship, influencing and
impacting each other.

3.