An Empirical Assessment of the Effects of Fiscal Devaluation on Bilateral Trade

Abstract

The central objective of this thesis is to investigate empirically the effects of fiscal devaluation on bilateral trade. The idea of the tax policy tools to have the capability to mimic the effects of currency devaluation to gain external competitiveness dates back to gold standard age. However, the novelty that comes with the concept of a fiscal devaluation is that these fiscal policy tools are used in a budget-neutral way. Therefore, a fiscal devaluation is a fiscal policy option of a tax shift which envisages, in general terms, a shift from indirect taxes to direct taxes, and specifically, a shift from employer’s social contribution to the value added taxes by preserving budget balance. A fiscal devaluation may ensure a less expensive export and a more expensive import and thus, this might result in some effects comparable to the effects of currency devaluation to gain external competitiveness. In this thesis, employers’ social contribution and value added tax, which stand as the factors that represent typical fiscal devaluation, are embodied within the framework of a gravity model. The empirical model specified within this framework is applied to fixed effects vector decomposition technique in panel regressions for 22 OECD countries covering the 1980-2014 periods. The findings of this dissertation show that multilateral effects of fiscal devaluation improve trade balances due to dominant effects of reduction in employers’ social contribution on export even though asymmetric results of value added tax variables might distort the success of a fiscal devaluation. This result is important as it indicates that the positive spill-over effects of a fiscal devaluation surpass the negative one.