The impact of trade liberalisation and exchange rate undervaluation on exports, imports, and trade balance of Latin American countries (1970-2019)

By Marcos A. L. de Campos, Jose Luis Oreiro, Kalinka Martins da Silva

PKES Working Paper 2408

May 2024

This article aims to analyse the impact of exchange rate levels and trade liberalization that occurred in the 1980s and 1990s on the exports, imports, and trade balances of Latin American countries over the last five decades. The basic idea is to update the study conducted by A. Santos-Paulino and A. P. Thirlwall in 2004, which aimed to test the hypothesis that trade liberalizations in developing countries lead to a deterioration of the trade balance by boosting imports more than exports. Additionally, this analysis introduces the effect of the exchange rate on the trade balance through the currency undervaluation index created by Rodrik (2008). Data from seven Latin American countries between 1970 and 2019 were selected to estimate econometric models for exports, imports, and the trade balance. Although the inherent uniqueness of each Latin American economy makes it challenging to make general conclusions, the results show that currency undervaluation has a strong effect on export performance, and they also support the idea that trade liberalisation reforms generate imbalances in the trade balance in the long run. This negative effect of trade liberalization, however, can be offset by a proper exchange rate policy that aims to set an undervalued exchange rate. If trade liberalization is combined with a competitive exchange rate, then an increase in exports growth and in the trade balance as a ratio to GDP will be consequence of this smart combination of trade and exchange rate policies.

Keywords: Trade Liberalization, Real Exchange Rate and Trade Balance

JEL classification: F10 F15