Liberalization of import restrictions on capital goods and the balance of payments

This paper examines the impact of capital import liberalization on the balance of payments when protection takes the form of a quota and when it takes the form of a tariff. Since tariff liberalization affects tax revenues, the analysis of tariff liberalization allows for a fiscal imbalance and a mechanism by which the fiscal imbalance is covered, namely an inflation tax. The analysis shows that the economy experiences a series of balance of payments deficits following trade liberalization, but an open capital account reduces the magnitude of these deficits.