Trade Policy is Real News: Theory and Evidence

Abstract

<ns2:p>We evaluate the aggregate effects of changes in trade barriers when these changes can be implemented slowly over time and trade responds gradually to changes in trade barriers because firm-level trade costs make exporting a dynamic decision. Our model shows how expectations of changes in trade barriers affect the economy. We find that while decreases in trade barriers increase economic activity, expectations of lower future trade barriers temporarily decrease investment, hours worked, and output. Further- more, canceling an expected decline in future trade barriers raises investment and output in the short run but substantially lowers medium-run growth. These effects are larger when the expected reform is bigger. In the data, we find that countries with more trade growth after the General Agreement on Tariffs and Trade (GATT) rounds decreased investment and hours worked in the years leading to the tariff cuts, as predicted by our model.</ns2:p>