Economic policy uncertainty and trade: does export sophistication matter?

ABSTRACT

In spite of the recent surge of research interest on the economic effect of policy uncertainties, trade behaviour during times of policy uncertainties is still not fully understood. We use the trade gravity model to examine the effects of economic policy uncertainty (EPU) on the trade of 22 countries over the period 1997–2020, based on the argument that EPU inflates bilateral trade costs. Overall, our results indicate that bilateral trade, exports, and imports are all negatively and significantly affected by both domestic and foreign policy uncertainties. Moreover, we document substantial heterogeneous trade reactions to policy uncertainties across countries. Specifically, in more export-sophisticated countries, our results show that only foreign policy uncertainty has a significant and negative effect on trade; whereas in less export-sophisticated countries, trade is significantly and negatively affected by both domestic and foreign EPU. These findings point to the double vulnerability of less export-sophisticated countries to domestic and foreign policy uncertainties and, to the resiliency of more export-sophisticated countries to domestic policy uncertainties and to their vulnerability to foreign policy uncertainties.

KEYWORDS:

• Economic policy uncertainty
• trade
• export sophistication
• gravity model

JEL CLASSIFICATION:

• E32
• F14

Acknowledgements

We would like to thank Dr. Balaji Janamanchi for the helpful comments on the revised version of the paper. We are also grateful to the editor David Peel and two anonymous referees for their insightful comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ https://www.nytimes.com/explain/2022/03/09/business/gas-oil-russia-ukraine#how-much-oil-does-russia-supply..

² For more clarification on the derivation of Equation (5)(5) $T{F}_{odt}=\mathrm{e}\mathrm{x}\mathrm{p}\left[{\alpha }_o+{\beta }_d+{\phi }_t+{\psi }_{od}+{\gamma }_{1}lnEP{U}_{ot}+{\gamma }_{2}lnEP{U}_{dt}+{X_{odt}}^{\prime }\mathrm{\Gamma }\right]\times {\epsilon }_{odt}$(5) , we refer readers to ‘The Gravity Model’, by Anderson (2011).