Relationship between trade openness and economic growth in Latin America: A causality analysis with heterogeneous panel data

• DOI: http://doi.org/10.1111/rode.12358
• Date: 01 May 2018
• Published date: 01 May 2018
• Author: Lorenzo Escot,Adolfo Roquez‐Diaz

REGULAR ARTICLE

Relationship between trade openness and economic

growth in Latin America: A causality analysis with

heterogeneous panel data

Adolfo Roquez-Diaz

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Lorenzo Escot

2

1

Faculty of Economics, Complutense

University of Madrid, Spain

2

Faculty of Statistical Studies,

Complutense University of Madrid,

Spain

Correspondence

Lorenzo Escot, Faculty of Statistical

Studies, Complutense University of

Madrid, Av. Puerta de Hierro, num. 1,

28040, Madrid, Spain.

Email: escot@ucm.es

Abstract

We empirically analyze the causality relationship between

economic growth and international trade using new

advancements in the econometric methodology for hetero-

geneous panel data applied to Latin American countries.

First, we test for dependencies between the units of

cross-section (countries) and then we test for cointegra-

tion between growth and openness. Finally, we test for

Granger causality using a heterogeneous panel data test.

The results reject the hypothesis of general, unidirec-

tional, and homogeneous relationship between trade open-

ness and economic growth in Latin American countries

as a group. However, considering heterogeneity, we

found significant evidence of causality from trade liberal-

ization to economic growth in Chile, Peru, Nicaragua,

and Uruguay; we have found bidirectional causality in

Mexico and Honduras; and a causal relationship from

economic growth to trade liberalization in Colombia,

Costa Rica, Guatemala, and the Dominican Republic.

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INTRODUCTION

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Economic growth and trade openness

The aim of this paper is to test for causality relationship between economic growth and trade open-

ness among countries in Latin America, by evaluating the possible presence of cross-section

dependence (countries) and using the latest econometric advances as the error correction based

DOI: 10.1111/rode.12358

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©2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2018;22:658–684.

cointegration tests for panel data (Westerlund, 2007); the test for dependence on the cross-section

of De Hoyos and Sarafidis (2006); and the Granger noncausality test of heterogeneous panel data

models of Dumitrescu and Hurlin (2012).

Our empirical findings show that the hypothesis of homogeneous noncausality for both direc-

tions of causality was rejected. However, considering heterogeneity, we have found evidence of

causality in a subset of 10 countries, albeit in different directions, whose common denominator is

that these countries—except Uruguay—have applied strong unilateral liberalization policies in the

1990s, and negotiated and signed bilateral trade agreements in the 2000s with their main tradi ng

partners from outside Latin America, including the United States.

The relationship between trade openness and economic growth occupies an important space in

the economic literature particularly among developing countries (e.g., Keesing, 1967; Krueger,

1985; Giles & Williams, 2000). A large part of the discourse used by governments and multilateral

development institutions has been geared to linking policies for freer international trade with coun-

tries’economic development. It is also claimed to be one of the surest and quickest routes out of

underdevelopment. This liberalization, along with the extended, growing globalization process to be

seen in economic, financial and commercial, as well as other fields, forms part of the presen t world

economic context, which, since the end of the 1980s, has influenced most of the world’s countries.

From the 1990s onwards in the last century, many actions have taken place to liberalize foreign

trade in different parts of the world and particularly in Latin America, both through unilateral pref-

erential measures (basically tariff reduction and elimination of trade barriers) and preferential trade

measures (with agreements among two or three countries to provide mutual tariff rate reductions,

for part or the whole of the tariff area), or through free trade agreements (FTA) between the Uni-

ted States and Latin American countries. Furthermore, multilateral development institutions such as

the World Bank, International Monetary Fund (IMF) and the Organisation for Economic for Co-

operation Development (OECD) are encouraging developing countries to engage in programs for

liberalizing trade as a prior condition for receiving financial aid.

The argument put forward in the economic literature is that international trade may increase

competition, allow the use of comparative benefit to come into play, make it easier for countries to

purchase goods abroad, provide opportunities to access knowhow and new technologies and

strengthen entrepreneurial skills. The traditional theory on international trade predicts: gains from

trade openness at a national level by means of specialization, investment in innovation, improved

productivity, or better resource allocation. So, trade openness is expected to show a positive and

significant coefficient in growth.

However, previous empirical evidence throws up mixed results. On the one hand, Edwards

(1988), Krueger (1997), Frankel and Romer (1999), Wacziarg (2001, 2008), Parikh and Stirbu

(2004), among others, argue that there is a link between liberalization of international trade and

economic growth, Sachs and Warner (1997), argue that trade openness increases the convergence

rate, whereas Nugent’s (2002) study discovers both winners and losers, Yanikkaya (2003) obtains

a mixture of positive or no relationships, and those of Baliamoune-Lutz and Ndikumana (2007)

suggest that more opening up to trade has led to a divergence of income instead of convergence in

African countries. Finally, among the greatest sceptics are Rodr

ıguez and Rodrick (2000), who

severely question the validity of the econometric methodology and techniques used in the studies

of Dollar (1992), Edwards (1998), Sachs and Warner (1995); and that of Rodrik (2012), which

points out that regression models of economic growth tell us nothing about the effectiveness of the

policies (e.g., on trade) and the real motives of governments taking these measures.

Bearing this last point in mind, it is worth asking the following question, that is, if international

trade is the cause of economic growth should Latin American countries reduce tariff and para-tariff

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