March 22, 2017 / 9:12 AM / in 5 months

Protectionism may raise, not cut, trade deficits: ECB

FILE PHOTO: European Central Bank (ECB) headquarters in Frankfurt, Germany, July 29, 2016.Ralph Orlowski

FRANKFURT (Reuters) - Protectionist trade policies may increase, rather than reduce, a country's trade deficit, the European Central Bank said in a study on Wednesday, just days after finance chiefs of the world's top 20 economies dropped their pledge for open trade.

Seeking to reduce a large trade deficit, Donald Trump's U.S. administration has proposed a series of protectionist measures, such as new import duties.

The White House also wants to revisit some of its trade relationships, including with key partners Germany and China, which both sell more goods to the United States than they buy from it.

Indeed, the United States has already pulled out of the Trans-Pacific trade deal, asked for a review of the North American Free Trade Agreement and refused to reaffirm its pledge for open and free trade at the G20 meeting last weekend, raising fears that global trade will take a hit.

Yet the authors of the ECB paper -- published in its regular Economic Bulletin - believe the opposite recipe is needed.

They said liberalizing global trade and importing cheaper intermediate goods improves competitiveness, helping firms keep their cutting edge over international rivals and lifting the country's exports.

"Adopting policies that facilitate innovation and reduce protectionist barriers may help to improve an economy's competitiveness," the ECB paper said. "Multilateral initiatives aimed at trade and financial liberalization may also reduce an economy's external imbalances."

"Participating in global value chains may give an economy a temporary competitive edge that results –- in order to smooth consumption over time –- in a rise in its current account balance," the ECB added.

The study also appeared to dismiss the U.S. administration's claim that countries running big current account surpluses may be using unfair trade practices.

Instead, it argued that countries will view their competitive edge as temporary, behaving with caution as they expect others to liberalize trade to improve their own efficiency and restore competitiveness.

"As a consequence, in order to smooth consumption over time, part of the income gain in the domestic economy will be saved, which improves the current account balance," the ECB added.

It added that if the advantage is perceived as permanent, then the current account balance is likely to deteriorate as consumption and imports rise to match what income levels.

Editing by Jeremy Gaunt

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