INTERNATIONALTRADE AND ECONOMIC GROWTH Jacob A. Jordaan Utrecht University School of Economics j.a.jordaan@uu.nl Outline • Introduction • East Asia versus Latin America as case study • Why would trade foster economic growth? • Some main findings • How to identify the effect of trade liberalisation? • Trade and growth: an endogenous relationship? • Trade openness, growth, investment and growing trade • Discussion 2Lecture 3 Trade liberalisation and growth Literature • Singh, T. (2010) Does international trade cause growth? A survey. The World Economy, vol. 33.11, p. 1517-1564 • Frankel, J.A. and Romer, D. (1999) Does trade cause growth? The American Economic Review, vol. 89.3, p. 379-399 • Skip sections II.D and II.E • Wacziarg, R. and Horn Welch, K. (2008) Trade liberalisation and growth: New evidence. The World Bank Economic Review, vol. 22.2, p. 187-231 3Lecture 3 Trade liberalisation and growth Introduction • Period following WWII characterised by growing level of globalisation • Rising international trade primary component • Group of developed countries experienced rapid growth whilst increasing international trade • International organisations promoted free trade doctrine • IMF, GATT, World Bank • Supported by standard trade theory • Developing countries • Import substitution versus export promotion 4Lecture 3 Trade liberalisation and growth Free trade, income and growth • OECD (1998) “More open and outward oriented economies consistently outperform countries with restrictive trade and (foreign) investment regimes” • IMF (1997) “Policies toward foreign trade are among the more important factors promoting economic growth and convergence in developing countries” • Stiglitz (1998) “Most specifications of empirical growth regressions find that some indicator of external openness – whether trade ratios or indices of price distortions or average tariff levels – is strongly associated with percapita income growth” 5Lecture 3 Trade liberalisation and growth Stiglitz changed his mind 6 Trade liberalisation has not lived up to its promises. But the basic logic of trade – its potential to make most, if not all, better off – remains. If that potential is to be realised, first we must reject two of the longstanding premises of trade liberalisation: that trade liberalisation automatically leads to more trade and growth, and that growth will automatically “trickle down” to benefit all. Neither is consistent with economic theory or historical experience. Lecture 3 Trade liberalisation and growth Switch in trade policy • Developing countries differed in the type of trade policy they used to promote development. • In 1980s one of the largest policy interventions of the 20th century! • From import substitution to export promotion in Latin America 7Lecture 3 Trade liberalisation and growth Why the policy intervention? 8Lecture 3 Trade liberalisation and growth Latin America versus East Asia 9Lecture 3 Trade liberalisation and growth 10Lecture 3 Trade liberalisation and growth Not just trade liberalisation! • Report stresses the importance of a set of common, market-friendly economic policies, fostering • Higher accumulation • Better allocation • “Getting the fundamentals right” • In addition to this • Relation between government and markets • Government intervention • Relation with international goods and capital markets 11Lecture 3 Trade liberalisation and growth Implications for Latin America • Follow the example of East Asia! • World Bank’s advice • Export promotion • Liberalisation of economy • High sustained growth possible • Should not have detrimental effect on inequality • Trade liberalisation should lower inequality • Heckscher-Ohlin model • Low skilled labour abundant input in Latin America • Much less attention paid to the role of government, institutions, etc. • Neo-liberal structural adjustments sufficient? 12Lecture 3 Trade liberalisation and growth Impact trade liberalisation in LA • Impact on growth varied between countries • Increase in inequality • No major reallocation of labour between industries • ↑ use of skilled labour in all industries • Why? • Unskilled labour intensive industries where heavily protected • Trade liberalisation lowered prices • China more abundant in low skilled labour • Skill biased technological change • Foreign Direct Investment and Outsourcing 13Lecture 3 Trade liberalisation and growth Maybe it takes some time? Lecture 3 Trade liberalisation and growth 14 Esquivel, G. (2010) The dynamics of income inequality in Mexico since Nafta. Economia, vol. 12(1), p. 155-179 Trade and economic growth (1) • Variety of approaches in the literature • Trade, trade openness, trade liberalisation • Income, income growth, productivity • Static trade effects • Dynamic trade effects • Demand-side analysis: Relation between exports and growth • Time series approach • Majority of studies find positive relation • But period specific • Discussion on direction of causation 15Lecture 3 Trade liberalisation and growth Trade and economic growth (2) • Cross-sectional and panel data approaches • Mostly focused on supply-side issues • Country level studies • Relation between variety of trade and openness indicators and output, growth or productivity • Decrease in inefficiency • Increase in competition • Scale economies • Flows of technology • Imports, spillovers 16Lecture 3 Trade liberalisation and growth Trade and economic growth (3) • Overall, positive effect of trade variables • More recent studies are characterised by larger degree of heterogeneity • Findings have received substantial scrutiny • On the other hand: no findings that trade restrictions can exercise positive effects! • Firm level studies • Increasing importance of firm heterogeneity • Trade fosters productivity improvements • Higher productivity firms engage in trade 17Lecture 3 Trade liberalisation and growth How to identify effect of trade • Country case study • Very informative, but difficult to generalise • Natural experiment • Exogenous introduction of free trade • Difficult to find • Cross-sectional and panel data approach to relate indicators of trade or openness to outcome variable 18Lecture 3 Trade liberalisation and growth Key challenges Say we want to identify effect of trade or trade liberalisation • How to capture trade, openness, liberalisation? • How to aggregate and distinguish between different types of trade restrictions? • Issue of endogeneity • Estimated effect of trade biased upwards • Effect of trade liberalisation conditional on other policies and characteristics? 19Lecture 3 Trade liberalisation and growth Problem of endogeneity Frankel and Romer (1999) AER Does trade cause growth? 20Lecture 3 Trade liberalisation and growth Y = income T = international trade W = intra-country trade P = proximity S = size + Solution: geography based instrument • Find variable that is sufficiently related to trade and unaffected by income • Use this as instrument for endogenous trade variable • Geography based trade Lecture 3 Trade liberalisation and growth 21 ij = countries D = distance N = population A = area L = landlocked countries B = common border Use estimated coefficients to calculate trade/GDP for each country Suitability of instrument Lecture 3 Trade liberalisation and growth 22 OLS and IV findings Lecture 3 Trade liberalisation and growth 23 Components of income Lecture 3 Trade liberalisation and growth 24 Y = output K = capital S = schooling N = labour A = productivity Effects of trade Lecture 3 Trade liberalisation and growth 25 Growth effect of economic openness • Wacziarg and Horn Welch (2008) World Bank Economic Review • Extend upon Jeffrey Sachs and Andrew Warner (1995) Economic reform and the process of global integration. Brooking Papers on Economic Activity, vol. 1995(1) • Cross section of countries • Average GDP/Cap growth 1985-1970 as function of initial GDP/Cap plus additional regressors • Dummy variable whether a country was “open” or “closed” to trade in this period • Findings show significant, positive and sizable effect • Received substantial criticism • Wacziarg and Welch • Update, extend and use time variation Lecture 3 Trade liberalisation and growth 26 Openness to trade 1960-2000 Lecture 3 Trade liberalisation and growth 27 Trade openness Lecture 3 Trade liberalisation and growth 28 Trade openness • Dummy approach • Trade liberalisation data • When did a country start to meet all five criteria? • Two approaches in W&W paper • Between effects (in line with Sachs and Warner) • Within effects; panel data approach Lecture 3 Trade liberalisation and growth 29 Replication of Sachs and Warner Lecture 3 Trade liberalisation and growth 30 Liberalisation and growth Lecture 3 Trade liberalisation and growth 31 𝐿𝐼𝐵𝑖𝑡 = 1 if t is larger than year of liberalisation and no reversal of trade policy reforms have occurred Timing of effects: growth Lecture 3 Trade liberalisation and growth 32 Timing of effects: investment Lecture 3 Trade liberalisation and growth 33 Timing of effects: (exp+imp)/GDP Lecture 3 Trade liberalisation and growth 34 Identifying timing of effects from growth, investment and openness Lecture 3 Trade liberalisation and growth 35 Empirical findings Lecture 3 Trade liberalisation and growth 36 Country heterogeneity Lecture 3 Trade liberalisation and growth 37 Success case: South Korea Lecture 3 Trade liberalisation and growth 38 Investment and trade Lecture 3 Trade liberalisation and growth 39 Mexico as Latin American case Lecture 3 Trade liberalisation and growth 40 Investment and trade Lecture 3 Trade liberalisation and growth 41 Trade and growth • Strong notion that trade is good for income, growth, etc. • International organisations clearly follow this line • LA versus EA • Evidence: global support for positive association trade and growth • Empirical studies • Variety of settings, measurements of trade and trade liberalisation • Important to recognise limitations of empirical approaches • But where is evidence that trade restrictions foster growth? • Papers good examples of key topics and issues • Likely that trade liberalisation is necessary but insufficient condition? Lecture 3 Trade liberalisation and growth 42 Discussion points (1) How does research on the growth effects from trade relate to trade theory? Lecture 3 Trade liberalisation and growth 43 Discussion points (2) What types of effects could/should we expect from trade / trade liberalisation / trade openness? Lecture 3 Trade liberalisation and growth 44 Discussion points (3) What are the policy implications of the empirical findings? Lecture 3 Trade liberalisation and growth 45