Trade openness and its impact on economic growth

Trade nudity and its impact on frugal off instituteThe main objective of this chapter is to bem apply an overview of what has been said in the literature regarding guile nudity and its impacts, mainly on ripening and impression to international shocks. Infact, the benefits and salutes of increased desegregation remain the subject of a hotly contested debate. class 2.1 provides an overview of the theoretical perspective of diverse authors. Section 2.1.1 and 2.1.2 elabo drift on the impact of guile on ontogenesis and pic to out-of-door shocks respectively. Finally, section 2.2 reviews the empirical literature.2.1 Theoretical review2.1.1 Trade and harvest-tideThe net effect of pile receptiveness on stinting suppu proportionalityn has been and remains a subject of much controversy. It is well known that menstruums of spread outness generate widely distri andedly been associated with prosperity while protectionism has been the companion of recessions. beingness supranational treat has experient exponential yield over the past two decades. L. Fontagn and M. Mimouni (2000) have stated that since the end of the European recovery after World War II, tariff grade have been divided by 10 at the gentleman level, international craftiness has been multiplied by 17, world income has quadrupled, and income per capita has doubled (p. 2).An economys nudity is said to be one of the key de bourneinants of its proceeds, along with human cracking, the investment ratio and the rate of population reaping (The Deutsch imprecate Research, 2005). Countries that have successfully indulged in international parcel out, opened themselves to foreign send investment and attracted foreign workers experienced much steeper economicalal harvest-festival than countries that have failed to become integrated into the global economy.Explanations brought forward by The Deutsch stick Research (2005) on how increased flock boosts evolution are move from the neoclassical mint model, the technological transfer argument and the institutional improvements argument.In order to explain the neoclassical model of international dish out, one should go back to Adam Smith (1776) and David Ricardo (1817). They showed that two countries with absolute and comparative cost advantages quite a little benefit from trade given that each country specialises in producing the good that it can manufacture at a relatively subvert cost. The total turning of manufactured goods that both countries can consume indeed increases and higher welfare follows. However, it is to be noned that economic growth is not an immediate consequence.Technology transfer occurs via the importing of high-tech capital goods, toil facilities, patents and licences, as well as knowledge-intensive services. Further to a greater extent(prenominal), the importing of new technologies in like manner stimulates the suppuration of ho use up servant technology via the imitation and enhancement of imported products. So trade accelerates technological progress, which in turn is the key source of long- landmark economic expansion according to growth theory.The institutional framework also plays a major division. It encompasses improving infrastructure, boosting capital market efficiency and safeguarding property rights. This lick is facilitated by increasing international competition, which prompts domestic companies to continually optimise their occupation processes and develop new products this also speeds up technological progress and thence boosts economic growth.In the said(prenominal) breath, Grossman and Helpman (1991) established that openness enhances economic growth through the following channels. Firstly, trade enlarges the available variety of intermediate goods and capital equipment, which can expand the productivity of the countrys early(a) resources. Secondly, trade permits underdeveloped countries the rag to improved technology in deve loped countries, in the form of corporate capital goods and thirdly, trade allows intensification of capacity utilization that increases products produced and consumed.To Fontagn and Gurin (1998), openness is surely a prerequisite, not the engine of growth. It simply fuels the engines of investment, reform and credibility.The trade surgery of individual countries tends to be a good indicator of economic functioning as well. Performing countries tend to record higher rates of gross domestic product growth. The majority of developing countries have joined the World Trade validation (WTO) and have taken initiatives aimed at opening their economies. Nevertheless, the outcome has not been consistently domineering since export performance sometimes remains disappointing and these countries steadily follow contrasted schooling paths. Gurin (1999) pointed out that there is no regular gain in growth associated with the binding to the multilateral rules of international trade. Accor dingly, Rodrik (2000) argues that integration into the world economy hardly substitutes for a development strategy.Nonetheless, some developing countries record high growth rates by specialising in recess markets and concentrating their export markets, while other developing countries record more lapse back rates of growth with a well diversified array of products and assistant countries. In other crusades, successful performance is the result of a gilt product or market penetration since the beginning. Successful performance can also be gauged in toll of a countrys ability to vary its export profile to changing patterns of world demand.The phenomenal differences among the growth rates of the eastern Asian, the Latin American, and Sub-Saharan African countries over the last several(prenominal) decades have stimulated a renewed interest in the do of trade policies on growth. During well-nigh of the 20th century, import substitution industrialisation (ISI) strategies domina ted most developing countries development strategies. While developing countries in Latin America that followed ISI strategies experienced relatively lower growth rates, East Asian countries, that employed export-promotion policies, consistently outperformed other countries. This probably explains why a growing body of empirical and theoretical research has shifted towards examining the relationship amidst trade relaxation and the economic performance of countries since the late 1970s.2.1.2 Trade and photo to External ShocksTrade provides countries with new growth opportunities but also exposes them to outside shocks. Many economists believe that, though openness to trade increases average gross domestic product growth rates, it also raises produce volatility by exposing countries to terms-of- trade shocks. The term picture is often brought up when referring to film to external shocks. Vulnerability refers to organic characteristics which render countries prone to exogenic shocksOpen economies are subject to external shocks and Rodrik (1998) has argued that more open economies have bigger governments, because government spending is apply to smoothen those external shocks.The pic of countries to some types of external shocks should be lessen when these countries exports are better diversified. More specifically, the effect of trade openness on growth volatility, might it be every negative or supreme on average, is presumable to be exacerbated when the country in question exports either a relatively low-pitched set of products, or sells its goods to a humiliated number of destination markets. The argument is that a higher degree of parsimony in exports would imply that any idiosyncratic price shock experienced is more likely to have a substantial impact on the countrys terms of trade, and this would then induce great fluctuations in a countrys growth process. Furthermore, a higher degree of diversification would likely imply that a country is i nvolved in a larger number of both implicit and explicit international insurance schemes, which would similarly serve as a cushion against such fluctuations.It has been argued that the structure of developing countries exports makes those countries particularly threatened to external shocks. Michaely (1958) showed five decades ago that countries with lower GDP per capita tend to be characterized by a higher commodity concentration of exports and argued that as a result, shocks affecting individual export products can have significant effect on boilersuit export performance and potentially on economic performance in developing countries.However, it is to be noted that many excellent states manage to generate a relatively high GDP per capita when compared to other developing countries in spite of their high motion picture to exogenous economic shocks. This would seem to suggest that there are factors which may offset the disadvantages associated with such vulnerability. This phe nomenon was termed by Briguglio (2003) as the Singapore Paradox, referring to the reality that although Singapore is highly overt to exogenous shocks, this small island state has managed to register high rates of economic growth and to attain high GDP per capita. This reality can be explained in terms of the ability of Singapore to build its resilience in the face of external shocks.Practitioners keep wondering whether being open, or in the process of opening up, can determine long negative effectuate linked to an increased exposure to external shocks or greater try out on certain actors. The open question is the following does trade openness or the process of opening up magnify the risk exposure of the open economy and/or increase uncertainty towards the future, with negative consequences on its welfare? This question does not have a once-for-all answer. It concerns, in general terms, the issue of the balance between the advantages of trade openness and the drawbacks of a grea ter exposure to shocks and uncertainty.The simplest analysis of risk suggests that at low levels of trade (as typical in developing economies), further trade liberalisation would tend to decrease risk exposure, because (larger) world markets with many players are likely to be more stable than (smaller) domestic ones (Winters, 2002).The hypothesis of a likely long term negative welfare effect of exposure to external shocks and uncertainty a sort of vulnerability hazard induced by trade openness indeveloping countries (Montalbano et al., 2006 and 2008 Guillaumont, 2007a, 2007b UNUWider 2008b) has been supported by a number of considerations Dercon (2001) underlines the role of openness as a vehicle for an entirely new set of shocks and incentives able to put traditional mechanisms under pressure and hamper sight standard management strategies Calvo and Dercon (2003 and 2007) and Ligon and Schechter (2003 and 2004) suck up how risk averse households will have lower levels of wel fare or a lower expected receipts if they face greater variation in future breathing in, as it is more likely in the case of trade openness Winters (2002) and Winters et al. (2004) suggest that trade openness could alter households optimal portfolio leading to sub-optimal choices, especially for the paltry, because of a poor ability to bear new risks and weak capabilities to insure themselves against adverse impacts or simply because their behaviour can be negatively affected by rising uncertainty.2.2 Empirical ReviewDo open economies grow fast-paced than closed economies? Almost all empirical growth studies have provided an approbative answer to this question. The reason for this strong bias in favor of trade rest is partly lay down on the conclusions of a wide take to the woods of empirical studies, which claimed that outward-oriented economies consistently have higher growth rates than inward-oriented countries. It is also partly due to the tragic failures of import-subs titution strategies, especially in the 1980s and misinform expectations from trade liberalization.Levine and Renelt (1992) show that trade openness may affect growth through investment. Continuous openness may lead to faster long-run growth since openness allows larger access to investment goods. Trade liberalization provides incentives for foreign direct investment nevertheless, foreign investment may crowd-out domestic investment.Rodriguez and Rodrik 1999 also emphasize the indefinite sign of the effects of trade on growth. Net effects are positive if the resource allocation determined by trade policy promotes sectors that generate more long-run growth, but are negative otherwise.Economic volatility has been shown to reduce economic growth (Ramey and Ramey, 1995 Martin and Rogers, 2000 Imbs, 2007) and the positive growth impact of trade may therefore be attenuated if it leads to significant exposure to external shocks.Terms of trade volatility is probably the most widely used me asure for external shocks. A number of studies have used quantitative, multi-sector equilibrium models to analyse the effect of terms of trade shocks on output volatility. Kose (2002) mystifys that world price shocks play an most-valuable role in driving business cycles in small open developing economies. His results confirm the results of earlier work by Mendoza (1995) or Kose and Riezman (2001).A number of recent studies have analysed the relationship between terms of trade shocks and changes in GDP growth in vector auto- arrested development (var) models. Ahmed (2003) uses a VAR model to study the sources of short-term fluctuations in the output of six Latin-American countries and dumbfounds that changes in the terms of trade and foreign output play a moderate role in driving output fluctuations. exploitation industry-level data, di Giovanni Levchenko (2009) check into the channels through which trade openness might affect volatility. They find a strong positive correlation between the risk guinea pig of exports and the variance of terms of trade and also found that export specialism affect macroeconomic volatility. They find that trade openness appears to lead to countries proper more specialised in their exports. This is problematic given that openness is likely to also expose a country to a greater number of shocks.Trade openness may expose economies to external shocks, but may also act as a buffer against domestic shocks. The overall impact of openness on volatility is therefore an empirical question. Easterly, Islam and Stiglitz (2001) and Calderon et al. (2005) find that higher trade openness leads to larger growth volatility. In contrast, Kose et al. (2002) do not find that trade openness have a blue effect on GDP volatility.Most studies on economic vulnerability provide empirical picture that small states, particularly island ones, tend to be characterised by high degrees of economic openness and export concentration. These lead to exposur e to exogenous shocks, that is, economic vulnerability, which could constitute a disadvantage to economic development by magnifying the element of risk in growth processes, without necessarily pliant the overall viability. Cordina (2004) shows that increased risk can adversely affect economic growth as the negative effects of downside shocks would be commensurately larger than those of positive shocks. The high degree of fluctuations in GDP and in export loot registered by many small states is considered as one of the manifestations of exposure to exogenous shocks.In the analysis of the linkages between trade openness and volatility, for instance, an extensive use of add-in data appears. Among the most recent exercises, Kose et al. (2003) Hnatkovska and Loayza (2004) Wolf (2004) Calderon et al. (2005) use panel data to measure the external exposure of a worldwide prove of countries by the sensitivity of first and second moments of economic growth (average rate and standard devia tion) to openness and financial shocks. They also allow the possibilities of non-linearities by allowing growth and volatility effects to vary with the level of economic development. On the same wake, Loayza and Raddatz (2006) apply semi-structural VAR to a panel of 90 countries with annual observations for the period 1974-2000 in order to isolate and standardise the shocks estimate their impact on GDP and examine whether and to what extent this impact depends on the domestic conditions.4 Using this technique, as mentioned, they show that trade openness magnifies the output impact of external shocks. Santos-Paolino (2007) too, who applies the same Panel VAR approach for a selection of crib death from the Caribbean, emphasises the negative impact of terms of trade shocks on certain vizor and real output volatility. Malik and Temple (2006), in their effort to explain differences in output volatility fordwise developing countries, use instead a Bayesian method to highlight explanat ory variables that are robust across a wide range of specifications. They show the pervasive role of geography in determining aggregate volatility since remoteness is associated with a wish of export diversification, a significant phenomenon of high volatility of terms-of-trade and output of the more remote countries is apparent. This result is not sensitive to the precise regression specification, nor it is compulsive by the contrasting geographies of low income and high income countries.Concerning the analysis of the linkages between trade openness and economic crises, Cavallo and Frankel (2007), following closely the definition of Calvo et al. (2003), Frankel and Rose (1996) and Frankel and Wei (2004), use a Probit model to measure the probability of a sudden decrease in the magnitude of net capital inflows exchange market pressure and output loss for a set of 141 countries for the period 1970-2002. They find evidence that trade openness makes countries less under attack(pre dicate) to sudden stops and up-to-dateness crises. A special feature of this work is that they address the problem of endogeneity of trade, victimization gravity estimates to construct an instrumental variable for trade openness based on geographical determinants of bilateral trade which are supposed to be exogenous.In a slight different exercise, Glick and Rose (1999) explain regional contagion of crises, using a binary probit equation across countries via maximum likelihood. They use cross sectional data for 161 countries in five different episodes of widespread currency instability. Their conclusion complement that of Cavallo and Frankel (2007), arguing that no military issue who is the first victim of the speculative attack and what factors are behind it there is a strong evidence that currency crises tend to spread regionally because of trade linkages. It emerges from the above how current analyses remain basically ex expect assessments, mainly targeted to issues not dire ctly linked to vulnerability. An additional effort is indispensable to build a sound methodology to assess vulnerability to trade openness.A. Federici and P. Montalbano in a paper entitled Assessing vulnerability to trade openness a cross-country analysis offer a substantive percentage to current debate on the effects of trade openness on developing countries vulnerability. The main result of this cross countries empirical test is to highlight a robust and significative statistical relationship between inlet volatility linked to trade openness and a positive consumption gap, i.e. the presence of negative shocks on consumption growth. This phenomenon remains covered up by simple data analyses and largely overlooked by current empirical literature on openness and growth. This paper demonstrates that situations of vulnerability to trade can co-exist with a positive trade and growth relationship. Some countries keep higher probability to be worse off in case of negative external shoc ks, because of endogenous characteristics (resilience) and/or the use of inadequate deal strategies (responsiveness).Empirical work on the construction of an economic vulnerability forefinger (Briguglio, 1995 Briguglio and Galea, 2003 Farrugia, 2004) is often based on the premise that a countrys proneness to exogenous shocks stems from a number of inherent economic features, including high degrees of economic openness (measured as the ratio of international trade to GDP), export concentration (measured by the UNCTAD index of merchandise trade) and dependence on strategic imports (measured as the ratio of the imports of energy, food or industrial supplies to GDP). All vulnerability indices using these or similar variables come to the conclusion that there is a tendency for small states to be more economically vulnerable than other groups of countries.L. Briguglio, G. Cordina, N. Farrugia and S. Vella (2008) provide an report as to why inherently vulnerable countries may register h igh levels of GDP per capita. It is argued that countries may be economically successful because they are inherently not vulnerable, or because they are resilient in the face of the vulnerability they face. The obverse is also true, in that countries may be unsuccessful because they are not sufficiently resilient. The paper has also shown that GDP per capita is positively related to economic resilience and negatively related to inherent economic vulnerability. Furthermore, per capita GDP is found to be more sensitive to resilience variables than to vulnerability variables.H. Yanikkaya (2002) showed that trade liberalization does not have a simple and straightforward relationship with growth using a large number of openness measures for a cross section of over 100 developed and developing countries observed from 1970 to 1997. The regression results for numerous trade intensity ratios are mostly consistent with the existing literature. However, contrary to the conventional view on th e growth effects of trade barriers, our estimation results show that trade barriers are positively and, in most specifications, significantly associated with growth, especially for developing countries and they are consistent with the findings of theoretical growth and developmentliterature.2.3 ConclusionMuch has been said in the literature regarding trade and growth. However, the more exposed to trade a country is, the more vulnerable it is to shocks coming from abroad. But nonetheless, economists believe that trade openness promotes economic growth. These have led some observers to identify an interrelationship between openness to trade, output volatility and growth.