Trade Imbalances, International Investment, and a Limitation of Lerner's Symmetry Theorem

Abstract

This paper sounds a caution to international trade economists, demonstrating that the equilibrium trade imbalances implied by most models of international investment disturb the symmetry between import tariffs and export taxes found by Lerner (1936). When trade is unbalanced, Lerner's equivalence result holds only when (i) trade tax revenue is redistributed among consumers, (ii) neither the import tariff nor the export tax would be prohibitive, and (iii) the value of trade imbalance at world prices is invariant to instrument choice. The last condition implies that Lerner symmetry generally will not obtain in many otherwise standard trade models with international investment, since remittances to foreign investors - a source of permanent trade imbalances- typically depend on both relative and absolute local prices, and thus on the government's choice of trade tax instrument. Endogenizing trade policy only exacerbates the asymmetry, since international investment influences government preferences over trade policy instruments as well as levels. Notably, Lerner symmetry can be resurrected by introducing a third policy tool in the form of a direct a tax on international investment returns. Future work therefore should either reinstate Lerner symmetry by adopting investment taxes, or at very the least, acknowledge the trade tax asymmetry inherent to models with international investment.