Lately, Lebanon has been overwhelmed by hyperinflation: the value of the Lebanese Pound is plummeting as compared to the United States Dollar. More and more Lebanese Pounds are needed to purchase a dollar. The devaluation is partially caused by the fact that outflows of foreign currency from Lebanon are greater than inflows of foreign currency. Part of the problem is that for decades, Lebanon has been operating with a trade deficit, which means that it is paying more foreign currency for its imports than it earns from its exports. This means that there is a leakage of foreign currency from the Lebanese economy. So how can we improve the net trade balance to prevent leakages of foreign currency that result in further devaluation of the Lebanese Pound?
Well, the government can manage trade policies to interfere with foreign trade activities. Two potential instruments that a government can use are subsidies and tariffs.
When a government subsidies a locally produced product, the supply curve related to this product shifts from S0 to S1. This results in the price of this product decreasing from P0 to P1 which then leads to an increase in the quantity demanded from Q0 to Q1. By doing this, governments can incentivize their local producers to increase their output at lower prices which then makes the locally produced product more attractive to consumers than a more expensive imported alternative. If the local suppliers are able to fully satisfy local demand for their product, they could go on to produce excess amounts that could then be exported to other countries.
When a government introduces a tariff on an imported product, the supply curve related to the imported product shifts from S0 to S1. This results in the price of this imported product increasing from P0 to P1 which then leads to a decrease in the quantity demanded from Q0 to Q1. The tariff applied by the local government sets a markup to the price of the import product making it more expensive and thus less attractive to consumers as compared to locally produced products. This encourages consumers to buy local products instead of imported ones.
At an aggregate level, if local production levels across more and more product types increases to satisfy a bigger proportion of demand, the need for imports will decrease. Suppliers could even begin to export products. Increased production levels can also increase employment opportunities. At the same time, if at an aggregate level, consumers are willing to switch from imported products to locally produced products, the aggregate demand for imports will decrease which means fewer quantities of these products will be imported. The decrease in total import levels and or the increase in total export levels will result in a higher net trade position, or in other words a decrease the trade deficit or even result in a trade surplus if the total import level is lower than the total export level.
It’s worth mentioning that tariffs and subsidies should not be used as long term solution. Imposing tariffs on imports can result in retaliation from other countries in which they impose tariffs on Lebanon’s exports. Also, constantly subsidizing local production, requires funds that the government may not always have available. However, doing so on the short run motivates local suppliers to increase production which can help improve employment and development of domestic industries for future sustainability.
You may be thinking that this sounds like a lot of theory. Let’s take a look at an example of a country that used these policies. The Brazilian government imposes tariffs on imports and subsidizes local production. Additionally, the Brazilian government entered into several trade agreements with other countries to facilitate its exports. By doing so, Brazil was able to overcome its trade deficit and even operate at a trade surplus for many years.
The Lebanese Ministry of Finance, Ministry of Economy and Trade, and Ministry of Foreign Affairs should work together to enter into trade agreements with other countries to promote Lebanese exports, impose tariffs on imported products to shift local demand away from imported products toward domestic products and subsidize the production of local goods and services. By decreasing the net outflow of foreign currency from Lebanon, the Lebanese government can better manage the exchange rate and reduce inflation levels. This leads to more sustainable economic growth and more productive employment.