The Impact of Differential COVID-19 Pandemic Containment Policies on International Trade and Capital Flows

Abstract

ABSTRACT This article develops a two-period two-country model to examine the impact of differential COVID-19 pandemic containment policies on international trade and capital flows. The theoretical analysis shows that asymmetric labor supply shocks resulting from the pandemic generate capital outflows from more affected countries to less affected ones, with the former running current account deficits. The greater the asymmetry in supply shocks, the more pronounced the impact on cross-border capital and trade flows. As the pandemic abated, these flows reversed, creating significant fluctuations over the pandemic cycle. However, globalization acted as a risk-sharing mechanism, moderating potential welfare losses. Using panel data from 42 countries, we investigate how specific containment policies like workplace closures and home isolation mandates affect trade and capital flows. Contrary to findings using higher frequency data, our empirical results confirm key predictions of our model, suggesting more stringent temporary containments, while dampening economic activity initially, may reduce COVID-19 cases and induce current account surpluses and capital inflows over a longer horizon.