Economic policy uncertainty and trade: does export sophistication matter?

In spite of the recent surge of research interest on the economic effect of policy uncertainties, trade behaviour during times of policy uncertainties is still not fully understood. We use the trade gravity model to examine the effects of economic policy uncertainty (EPU) on the trade of 22 countries over the period 1997–2020, based on the argument that EPU inflates bilateral trade costs. Overall, our results indicate that bilateral trade, exports, and imports are all negatively and significantly affected by both domestic and foreign policy uncertainties. Moreover, we document substantial heterogeneous trade reactions to policy uncertainties across countries. Specifically, in more export-sophisticated countries, our results show that only foreign policy uncertainty has a significant and negative effect on trade; whereas in less export-sophisticated countries, trade is significantly and negatively affected by both domestic and foreign EPU. These findings point to the double vulnerability of less export-sophisticated countries to domestic and foreign policy uncertainties and, to the resiliency of more export-sophisticated countries to domestic policy uncertainties and to their vulnerability to foreign policy uncertainties.