The relationship between trade openness and economic growth: Some new insights on the openness measurement issue

• Published date: 01 January 2018
• Author: Mariana Vijil,Marilyne Huchet‐Bourdon,Chantal Le Mouël
• DOI: http://doi.org/10.1111/twec.12586
• Date: 01 January 2018

ORIGINAL ARTICLE

The relationship between trade openness and

economic growth: Some new insights on the

openness measurement issue

Marilyne Huchet-Bourdon

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Chantal Le Mou€

el

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Mariana Vijil

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1

SMART-LERECO, AGROCAMPUS OUEST, INRA, 35011, Rennes, France

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The World Bank, Washington DC, USA

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INTRODUCTION

Empirical evidence tends to show that in the long run, more outward-oriented countries register

higher economic growth (Sachs & Warner, 1995; Edwards, 1998; Frankel & Romer, 1999; Dollar

& Kraay, 2004; Lee, Ricci, & Rigobon, 2004; Freund & Bolaky, 2008; and Chang, Kaltani, &

Loayza, 2009; among others). According to some authors, however, most of this work suffe r from,

at least, two serious shortcomings that make their results questionable: the way trade openness is

measured and the retained estimation methods (Rodriguez & Rodrik, 2001, for instance).

Many different measures of trade openness have been proposed and used in empirical analyses

of the relationship between openness and growth: measures based on trade restrictions/distortions

(e.g., Edwards, 1998; Harrison, 1996; Pritchett, 1996; Yanikkaya, 2003), “qualitative”indices

aimed at classifying countries according to their trade and global policy regim e (such as the World

Development Report 1987 outward orientation index or the openness indices proposed by both

Sachs & Warner, 1995; and Wacziarg & Welch, 2003), or outcome-based measures based on trade

flows (such as the trade dependency ratio, see, e.g., Frankel & Romer, 1999; Irwin & Tervio,

2002; Frankel & Rose, 2002; Dollar & Kraay, 2004; Squalli & Wilson, 2011). These various mea-

sures relate to different definitions of openness: from trade policy or global policy orientation to

the wider view that the outward orientation of a country depends not only on its policy orientation

but also on a set of non-policy factors (such as geography and infrastructure for instance).

In this paper, we focus on the widest outcome-based definition of openness. Our aim is to con-

tribute to the ongoing debate on the growth effect of trade by arguing that trade openness is a mul-

tidimensional concept that cannot be summarised to a single measure such as the commonly used

trade dependency ratio. Thus, following recent developments in growth theory and in inte rnational

economics, we propose a more comprehensive way of measuring outcome-based trade openness

taking into account two additional dimensions of countries’integration in world trade: the quality

and the variety of the exported basket. Indeed, according to the existing literature, both these fac-

tors are likely to affect positively growth, which call for considering them when measuring coun-

tries’trade openness in view of examining the relationship between trade and growth.

On the one hand, endogenous growth theory has provided a framework for efficiency gains and a

positive growth effect of trade through innovation incentives, technology diffusion and knowledge

DOI: 10.1111/twec.12586

World Econ. 2018;41:59–76. wileyonlinelibrary.com/journal/twec ©2017 John Wiley & Sons Ltd

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dissemination (Grossman & Helpman, 1991; Young, 1991). In these types of models, the introduction

of new varieties through imports leads to static gains from trade taking the form of increased produc-

tivity and domestic production growth, by making imported intermediate inputs cheaper and by relax-

ing technological constraints faced by producers through the access to new imported input varieties.

The consumption of increased variety also leads to welfare gains due to the love of variety. Dynamic

gains arise when the resulting growth fosters the creation of new domestic varieties that contribut e

further to economic growth. There is increasing evidence at the firm level on this regard; for example,

Bigsten, Gebreeyesus, and Soderbom (2016) recently found that input tariff liberalisation was associ-

ated with higher firm-level productivity in Ethiopia. Bas and Strauss-Kahn (2014) showed that French

firms importing more varieties of intermediate inputs increased their productivity by 2.5% and

exported more varieties. Goldberg, Khandelwal, Pavcnik, and Topalova (2010) showed that lower

input tariffs accounted on average for 31% of the new products introduced by domestic firms in India ,

thanks to increased firm access to new input varieties. However, there is no consensus on the magni-

tude of welfare gains, as these will depend on the share of new imported varieties in total consump-

tion (Arkolakis, Demidova, Klenow, & Rodriguez-Clare, 2008).

Inspired from theoretical developments on innovations incentives and knowledge spillovers,

Hausmann, Hwang, and Rodrik (2007) proposed an analytical framework linking the type of goods

(as defined in terms of productivity level) a country specialises in to its rate of economic growth.

To test empirically for this relationship, they defined an index aiming at capturing the productivity

level (or the quality) of the basket of goods exported by each country. Using various panel data

estimators during the period 1962–2000, their growth regression showed that countries exporting

goods with higher productivity levels (or higher quality goods) have higher growth performances.

These results suggest that what countries export matters as regards the growth effect of trade.

Hence, our measurement of trade openness should consider this quality dimension as a comple-

ment to the trade ratio (or the dependency) dimension.

On the other hand, monopolistic competition trade models with heterogeneous firms and

endogenous productivity provide theoretical support for a positive impact of trade openness on

growth. Indeed, the theory predicts a productivity improvement in the country due to a reallocation

effect after the exit of less efficient firms following trade liberalisation—or a reduction in transport

costs for example—(Melitz, 2003). Furthermore, a higher share of the most productive firms will

start exporting, which translates into an increase in the variety of exports. As exporters are more

productive on average than domestic firms, an increase in export variety can be associated to rising

country productivity. Based on this literature, Feenstra and Kee (2008) developed a model allow-

ing to link, across countries and over time, relative export variety to total facto r productivity using

a gross domestic product (GDP) function. They tested this relationship on the basis of exports to

the United States for a panel of 48 countries over the period 1980–2000 using three-stage least

squares regressions. Their empirical results indicated that there is a positive and significant rela-

tionship between export variety and average productivity. Furthermore, computing the gains from

trade in the monopolistic competition model of Melitz (2003), Feenstra (2010) shows that countries

with a greater export over GDP ratio will experience higher gains in terms of GDP per capita

growth, from export variety. Once again, these results suggest that, in addition to the trade depen-

dency ratio, the structure of countries’exports matters regarding the growth effect. Hence, our

measurement of trade openness should also consider this variety dimension.

Our empirical application draws on the Barro and Lee’s (1994) model, extended to account for

our set of three indicators of trade openness: trade dependency ratio, quality index and variety

index. Barro and Lee (1994) study empirical determinants of growth. They are in line with the

endogenous growth theory. Unlike the usual neoclassical growth model for a close d economy

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