Exchange and Capital Controls as Barriers to Trade

This paper considers the effect of exchange and capital controls on trade in the gravity-equation framework, in which bilateral exports depend on the distance between coun-tries, the countries ’ size and wealth, tariff barriers, and exchange and capital controls. The extent of exchange and capital controls is measured by unique indices. In view of the degree to which countries have liberalized their exchange systems, controls on cur-rent payments and transfers are found to be a minor impediment to trade, while capital controls significantly reduce exports into developing and transition economies. Thus, further capital account liberalization could significantly foster trade. [JEL F13, F31] In 1944, the Bretton Woods conference recognized the fundamental link betweenexchange and capital controls1 and international trade. One of the purposes of the International Monetary Fund, which was created at the conference, was to assist in “the elimination of foreign exchange restrictions which hamper the growth of world trade.”2 However, the maintenance of capital controls was not viewed as inconsistent with this objective, partly because capital controls were considered necessary for sup-porting the system of fixed exchange rates and thus fostering trade. More than 50 year