Trade and Growth

Warning: This post is probably more for my own benefit than for anyone else’s edification. If you’re tired of arguing about trade, then skip this post. And if you’re not interested in reading about some rather technical economic research, then skip this post. On the other hand, if you’ve always wanted to see examples of the actual evidence that makes lots of economists think that more trade can be (but isn’t always) a good thing, please read on.

I’ve just finished reading yet another paper on trade and growth. The literature on this topic is enormous, and growing by several papers per year. But that’s important, and (for the most part) probably a good thing.

The most peculiar thing seems to be happening, however. It is starting to seem like the discipline is tentatively considering something approaching the vague semblance of agreement about some aspects of how greater openness to international trade affects economic growth. In the past few years several different papers, using different methodologies, have concluded much the same thing: more exposure to international trade may cause faster economic growth and development, but does not always and necessarily do so, and the determinants of whether trade is good or bad for growth are institutions and other economic policies.

Put simply, this means that if a country is getting other sorts of economic policies basically right, and has a reasonably well-functioning government, then trade can enhance growth and development, and will raise the quality of life for many more people than it harms. But if a country only liberalizes trade without getting the rest of its house in order, more exposure to international trade by itself could make many more people worse off than it makes better off. (Important reminder: international trade, as with most economic transactions, generates some winners and some losers; what we’re interested in is which group is bigger, and how strongly affected they are.)

The number of papers agreeing on the broad outlines of this statement is starting to seem to me to be approaching a critical mass. The paper that I’ve just read is a good example of this thesis: “Openness Can be Good for Growth: The Role of Policy Complementarities”, Roberto Chang, Linda Kaltani, Norman Loayza, World Bank Policy Research Working Paper WPS3763, November 2005. (For a non-technical summary see here.)

They write:

We present some panel evidence on how the growth effect of openness depends on a variety of structural characteristics. For this purpose, we use a non-linear growth regression specification that interacts a proxy of trade openness with proxies of educational investment, financial depth, inflation stabilization, public infrastructure, governance, labor-market flexibility, ease of firm entry, and ease of firm exit. We find that the growth effects of openness are positive and economically significant if certain complementary reforms are undertaken.

They’re piling on to a lot of other good work in the past couple of years. For example:

• “Openness and Growth: What’s the Empirical Relationship?” by Robert E. Baldwin, NBER Working Paper No. 9578, March 2003.
  

  “This paper briefly surveys this literature and points out the main reasons for the disagreements [among economists concerning how a country’s international economic policies and its rate of economic growth interact]. [A]n important study by Francisco Rodriguez and Dani Rodrik (2001)… show[s] that openness simply in the sense of liberal trade policies seems to be no guarantee of faster growth. However, the conclusion of most researchers involved in either country studies or multi-country statistical tests – that lower trade barriers in combination with a stable and non-discriminatory exchange-rate system, prudent monetary and fiscal policies and corruption-free administration of economic policies promote economic growth – still seems to remain valid.”

• “Trade, regulations, and growth” by Caroline Freund and Bineswaree Bolaky, April 2004.
  

  “Trade does not stimulate growth in economies with excessive business and labor regulations. The authors examine the effect of openness on growth using cross-country regressions in both levels and changes. Results from the levels regressions imply that increased openness is associated with a lower standard of living in heavily-regulated economies. Growth regressions confirm that the effect of increased trade on growth is absent in these countries…The results imply that countries must create a sound business environment before trade can be used as an engine of growth.”

• “Globalization and Complementary Policies: Poverty Impacts in Rural Zambia”, by Jorge F. Balat and Guido Porto, NBER Working Paper No. 11175, March 2005.
  

  “We find that complementary policies matter… by expanding trade opportunities Zambian households would earn significantly higher income. [But] securing these higher levels of well-being requires complementary policies, like the provision of infrastructure, credit, and extension services.”

• “Trade Liberalization and Growth: New Evidence,” Romain Wacziarg, Karen Horn Welch, NBER Working Paper No. 10152, December 2003.
  

  “[T]here is a vast amount of heterogeneity across countries in the extent to which growth rose after trade reforms. While the average effect obtained in the large sample is positive, roughly half of the countries experienced zero or even negative changes in growth post-liberalization. Second, generalizations about the factors that may explain these differences are difficult to draw. The preexisting institutional environment of countries, the extent of political turmoil, the scope and depth of economic reforms, and the characteristics of concurrent macroeconomic policies all seem to have a role to play.”

Such papers seems to be part of an interesting, and notable, convergence of opinion about the effect of trade on growth.

Kash

UPDATE: Regular reader DOR reminds me that there’s one other point of consensus among economists about trade and growth that I think is fair to make: while there’s only a gradually emerging agreement that trade can be good for growth under the right circumstances, there’s near unanimous agreement that protectionism (or the lack of trade) never helps growth.

Even the seminal paper of Rodriguez and Rodrik (2000), “Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-National Evidence,” which really ignited the empirical research of the past few years by harshly (and fairly) criticizing the previous evidence that trade helped growth, said this:

“Let us close by restating our objective in this paper. We do not want to leave the reader with the impression that we think trade protection is good for economic growth. 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.

So let me amend my summary of the emerging consensus as follows: sometimes trade causes faster growth, and sometimes it doesn’t. But protectionism is never good for growth.