Export subsidies and the balance of trade

Abstract

We analyze the relationship between export subsidies and the balance of trade in a semi-small LDC type economy – facing fixed world prices for imports but negatively sloped demand curves for exports. The paper examines the dual role of export subsidies: as a mechanism to increase the competitiveness of exports and thus reduce the trade deficit and as a net injection of government spending, which will enlarge the trade deficit. The key finding are: (i) export subsidies, by themselves, will reduce the trade deficit only if the export price elasticity is very high and domestic prices are constant, (ii) for a lower price elasticity and/or changing domestic prices – because, say, a sector is at full capacity – export subsidies will worsen the trade deficit, (iii) when, however, export subsidies are accompanied by a reduction of government spending equal to the cost of the subsidies the trade deficit will decrease, while at the same time real GNP will increase.