Trade Reform and Macroeconomic Policy in Vietnam

The Asian crisis and the more recent global economic slowdown changed Vietnam's terms of trade adversely. Results from a global macro-model confirm that the consequences were a rural contraction exacerbated by deflation and consequent slower overall employment and GDP growth. Further simulations show that a unilateral trade policy reform could return the economy to its growth benchmark even while export demand remains slack. Although the short run gains from trade reform are directionally robust, their magnitude depends on the prevailing macroeconomic policy regime. If capital controls are to remain tight, a flexible exchange rate regime is superior to a fixed rate, since it frees monetary policy to combat deflation. In this case lost tariff revenue should be made up through direct taxes to preserve the fiscal deficit. If capital controls are ineffective, however, the gain in investment is larger and this changes the monetary and fiscal policy rankings. A fixed exchange rate regime is then more effective and an expanded fiscal deficit is growth enhancing in the short run.