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Do "open" economies really grow faster than others?

The view that openness to trade promotes economic growth has been called into question by two recent research papers at a time when developing countries are being exhorted to pursue policies of trade liberalization.

by Chakravarthi Raghavan


GENEVA: The policy advice to developing countries from the World Bank, the IMF and the OECD (and now the WTO) that liberalizing international trade and lowering tariff and non- tariff barriers promote growth has been viewed with scepticism in two recent research papers.

Both papers have been issued by the US National Bureau of Economic Research: one by Ann Harrison and Gordon Hanson, and another by Francisco Rodriguez and Dani Rodrik (who has recently taken over as the Research coordinator for the Group of 24 on International Monetary and Financial Issues).

Reviewing existing literature, both papers express scepticism about the assertions and claims.

The two research papers come at a time when trade negotiators from the industrial world and several from the developing world, preparing for the 3rd WTO Ministerial meeting at Seattle, are focusing on trade liberalization and large cuts in industrial tariffs of developing countries, demanded by the US and the EC, and promoted by free trade ideologues.

In the preparatory process, the negotiators are arguing about the levels and extent, whether it should be an open negotiating issue, or one whose final outcome would be set under the guise of "modalities" to predetermined bands and levels as the EC and the US are advocating, or whether it should all be a trade-off against other concessions (like the EC and the US opening up their own markets for agriculture).

But they generally do not challenge the view that liberalization promotes growth and welfare gains.

An earlier generation of studies (of the late 1970s and 1980s), capped by a World Bank-organized study in eight volumes (and which also got reflected in the Washington Consensus) which made claims about open economies growing more than others, subsequently received many critical reviews and challenges, on both the methodologies used and the conclusions drawn not being borne out by the facts. The World Bank subsequently has somewhat moved away from this dogma.

Rodriguez and Rodrik (April 1999), in reviewing the studies and conclusions most often cited in current literature to back the views about trade liberalization - those by David Dollar (1992), Jeffrey Sachs and Andrew Warner (1995) and Sebastian Edwards (1992, 1998) - and in doing their own calculations and using later data too, as well as using other empirical papers, suggest that the facts do not bear out the conclusions and claims and that many questions still remain.

"Unresolved issues"

Harrison and Hanson (January 1999), in their study "Who Gains from Trade Reform? Some Remaining Puzzles" (NBER Working Paper No W6915 - http://www.nber.org/papers), focus on what they call three "unresolved issues" with regard to the impact of trade reform.

They say that firstly, many studies that link trade reform to long-run growth "are surprisingly fragile." Examining the popular measure of openness introduced by Sachs and Warner (1995) - in "Economic Reform and the Process of Global Integration", Brookings Papers on Economic Activity - Harrison and Hanson say that it "fails to establish a robust link between more open trade policies and long-run growth."

The second puzzle identified by the two authors is the small impact of trade reform on employment in developing countries.

A third issue addressed by Harrison and Hanson relates to the evidence on the relationship between trade reform and rising wage inequality.

Focusing on the 1985 Mexican trade reform, they show that wage inequality in Mexico rose after the reform - a puzzling result in a Heckscher-Ohlin context (modification of the theory of free trade and comparative advantage) if Mexico is viewed as having a comparative advantage in producing low-skill-intensive goods.

Sceptical

In their paper, "Trade Policy and Economic Growth: A sceptic's guide to the cross-national evidence" (NBER Working Paper W7081), Rodrik and Rodriguez, after reviewing the much-cited recent studies, express scepticism "that there is a strong negative relationship" in the data between trade barriers and economic growth, at least in terms of "levels of trade restrictions observed in practice".

While strongly cautioning against drawing the conclusion, from their review, that trade protection is good for growth, the authors suggest that the search for a relationship between trade barriers and economic growth is "futile".

Rather, they suggest that research should focus on contingent relationships between trade policy and growth, and mention several issues in this area. They also suggest study and analysis of micro-econometric plant-level data sets that are available on questions like whether firms derive technological or other benefits from exports per se or whether efficient producers tend to self-select export markets, and whether causality goes from productivity to exports or vice versa.

This last raised by Rodrik and Rodriguez is of considerable interest and importance to developing-country policy-makers and decision-makers who are constantly hammered with the advice to focus on so-called export-led strategies for firms, encouraging investments in export sectors and industries.

An earlier study by Rodrik published this year by the Overseas Development Centre has also thrown considerable doubt on an export-led strategy and foreign investments in this regard, and he suggests that there is no evidence that for the economy as a whole, one dollar of investment in the export sector is of greater benefit than one in domestic sectors. He also throws doubt on some other myths now being associated with foreign investments.

In response to the critiques of the earlier studies about "openness", Dollar, Sachs and Warner, Edwards and Ben David constructed new indicators of openness - using a wider range of measures, including some subjective indicators and comparing the convergence experience among groups of liberalizing and non-liberalizing countries. All the studies purport to show stronger and more convincing results on the beneficial effects of openness than earlier literature, and their cumulative evidence is used for promoting the consensus view about growth- promoting effects of trade openness.

In their review of the latest literature, Rodrik and Rodriguez focus on the question whether countries with lower policy-induced barriers to international trade grow faster, once other relevant country characteristics are controlled for. The relevant question for these matters is the consequences of trade policies in question, rather than trade volumes.

At the minimum, the authors argue, the relationship between trade policy and economic growth remains very much an open question which has not been settled on empirical grounds. They are very doubtful that there is a "general, unambiguous relationship" between trade openness and growth that is waiting to be discovered.

Rather, they suggest the relationship is a contingent one and depends on a number of country and external characteristics. Research aimed at ascertaining the "circumstances under which open trade policies are conducive to growth (as well as those that may not be) and scrutinizing the channels through which trade policies influence economic performance is likely to prove more productive."

Rodrik and Rodriguez discuss some of the conceptual issues involved and the methodologies used in the latest bunch of literature (which are the most often- cited ones), and argue that without any claims to exhaustive surveys, the literature examined by them identify endemic weaknesses in the literature.

They disagree with the view (advocated, for example, by Prof. T.N. Srinivasan, himself a critic of the data and methods used) that given the voluminous amount of research and the similar conclusions drawn (about openness causing growth), these deserve serious consideration.

Rodrik and Rodriguez argue, on the other hand, that if a negative relationship between trade restrictions and economic growth had been convincingly demonstrated, the issue would not be generating so much empirical research. The persistence of interest in such research, they suggest, reflects the worry that existing approaches have not gotten it quite right.

Rather than the many subjective indicators of openness, using simple averages of taxes on imports and exports and the non-tariff-barrier coverage ratios conveys a more decent job of ranking countries according to the restrictiveness of trade regimes.

The two authors suggest some useful avenues for cross- national research on contingent relationships, including whether trade relationships operate differently in low- versus high-income countries, in small vs large, and countries with comparative advantage in primary commodities and those with manufactured goods. Also, are tariff and non-tariff barriers to imports of capital goods more harmful to growth than other trade restrictions? Is duty-free access to imported inputs for exports or export-processing zones good for growth?

On the issue of micro-econometric literature analysis of plant-level data sets, Rodrik and Rodriguez refer to a number of recent research papers which suggest that there is little evidence that firms derive technological or other benefits from exporting per se.

The more common pattern, they say, is that efficient producers tend to self-select into export markets, and causality is from productivity to exports, not vice versa.

On a cautionary note against using their study for the view that trade protection is good for growth, the authors add: "We know of no credible evidence - at least for the post-1945 period - that suggests that trade restrictions are systematically associated with higher growth rates.

"On the other hand," they add, "we believe that there has been a tendency in academic and policy discussions to greatly overstate the systematic evidence in favour of trade openness." (SUNS4441)

The above article appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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