Exchange and Capital Controls as Barriers to Trade


WP/98/81-EAWP/98/81


The significance of the link between exchange and capital controls and trade is
a fundamental key to the smooth functioning of the international economic and
financial system. During the past several decades, most countries have
liberalized controls on current payments and transfers, and the focus of
economic policy is increasingly shifting toward liberalizing controls over
capital account transactions. Generally, however, the theoretical effect of
exchange and capital controls on trade is somewhat ambiguous, and the
systematic empirical evidence remains limited.


This paper examines the effect of exchange and capital controls on trade for
1996 in the empirical gravity-equation framework, in which bilateral exports
depend on the distance between countries, the countries. size and wealth,
tariff barriers, and exchange and capital controls. The extent of exchange and
capital controls is measured by unique indices, which aggregate information on
142 individual types of control from the IMF.s Annual Report on Exchange
Arrangements and Exchange Restrictions.


Overall, exchange and capital controls represent a noticeable barrier to trade.
The specific impact of exchange and capital controls on trade, however, varies
depending on the level of development of a country and the type of control.
Controls on current payments and transfers are a minor impediment to trade,
while capital controls significantly reduce exports into developing and
transition economies, but not into industrial countries. These findings may
reflect the extent to which controls on current payments and transfers have
been liberalized worldwide, while the liberalization of capital controls has so
far focused largely on industrial countries. An implication of the study is
that further liberalization of exchange and capital controls can discernibly
foster trade.