Trade barriers, openness, and economic growth.

• Author: Madsen, Jakob B.

1. Introduction

   A recurring theme in international economics is the relationship between openness and economic growth. Based on postwar data that typically span the period from 1970 to 1990, there has, until recently, been a consensus of a negative relationship between trade barriers and growth and a positive relationship between growth and import penetration. However, these findings have been challenged by Harrison and Hanson (1999), Rodrik (1999), Yanikkaya (2003), and particularly, Rodriguez and Rodrik (2000). (1) Rodriguez and Rodrik (2000) seriously question the empirical method underlying the regression analysis in the most important studies that find a positive relationship between openness and growth. Rodriguez and Rodrik (2000) demonstrate that the positive correlation between growth and openness found by Dollar (1992), Ben-David (1993), Sachs and Warner (1995), and Edwards (1998) is not robust to various measures of openness and important control variables.

   Similarly, studies using pre World War II data consistently fail to uncover a robust positive relationship between openness and growth (see Bairoch 1972; Capie 1994; Foreman-Peck 1995; O'Rourke 2000; Clements and Williamson 2001; Irwin 2002; Irwin and Tervio 2002; Vamvakidis 2002). The empirical study of Vamvakidis (2002) is one of the few studies that consider the relationship between openness and growth over a long historical period. Using cross-section data over the periods 1870-1910, 1920-1940, 1950-1970, and 1970-1990, Vamvakidis (2002) finds either a negative or no relationship between growth and openness before 1970 and a positive relationship thereafter.

   A problem associated with most empirical studies is that cross-sectional data, as opposed to panel data, are used. This prevents them from controlling for fixed effects. More importantly, very little attention has been given to growth versus level effects of openness and, particularly, to the channel through which openness influences growth. Endogenous growth theories have highlighted trade as the principal channel through which knowledge is transmitted internationally (Grossman and Helpman 1991). The early endogenous growth models have been developed within the first generation endogenous growth framework, in which the level of research and development (R&D) activity and growth vary proportionally.

   Since the seminal paper of Jones (1995), however, it has been widely believed that first generation growth models are not consistent with the empirical evidence. In response to Jones's critique, endogenous growth theories have evolved into two distinct second generation growth models, namely, semi-endogenous and Schumpeterian growth models. Policies that seek to promote productivity have only temporary growth effects in the semi-endogenous growth models of Jones (1995) and Kortum (1997). In the Schumpeterian models of Aghion and Howitt (1998) and Howitt (1999), R&D can have permanent growth effects so long as R&D is increased along with income in the economy to counteract the increasing product proliferation. To allow for this possibility, knowledge spillovers have to be modeled following the Schumpeterian framework.

   The contribution of this article is twofold. First, an annual data set for a panel of 16 relatively homogeneous industrialized countries, which spans 137 years, is used to examine the productivity growth and productivity level effects of trade barriers and import penetration. (2) Because trade barriers and import penetration have fluctuated substantially over the last 137 years, the data yield ample identifying movements and, at the same time, enable one to control for country characteristics. Furthermore, it is tested whether openness has permanent or temporary output-growth effects.

   Second, the article tests whether openness influences growth because it enables countries to import knowledge that is produced in other countries. Recent developments within endogenous growth theory suggest that openness influences growth through the channel of imports (Romer 1990, 1992; Grossman and Helpman 1991; Rivera-Batiz and Romer 1991; Aghion and Howitt 1998; Baldwin and Forslid 2000). Although some studies have investigated the relationship between growth and knowledge spillovers, very few, if any, have explicitly investigated the issue in the context of openness. Domestic patent applications are used in this article to construct domestic and foreign stocks of knowledge, and bilateral trade shares are used to quantify trade-related spillover effects. Spillover effects through the channel of imports follow the theories described in Grossman and Helpman (1991), whereby productivity is enhanced by imports of intermediate products that embody technological knowledge. Similarly, in the model of Rivera-Batiz and Romer (1991), countries can tap into world knowledge through the channel of imports. It follows that imports that contain technological knowledge may increase productivity in the importing country; whereas, imports of products that do not embody technology might not influence growth at all. A problem associated with the empirical estimates of these models, following the seminal paper of Coe and Helpman (1995), is that knowledge spillovers are assumed to have only level effects as opposed to permanent growth effects along a balanced growth path. The possibility that knowledge spillovers may have permanent growth effects following the predictions of Schumpeterian growth theories is allowed for in the empirical estimates in this article.

   The literature is briefly surveyed in the next section, and the empirical framework and the empirical estimates are presented in sections 3 and 4. Sensitivity analysis is carried out in section 5, and section 6 concludes the article.

2. Trade Barriers, Openness, and Growth

   Why should openness impact positively on growth? The traditional development literature considered exports as growth-enhancing because of the positive productivity spillovers from the tradable to the nontradable sector and because exports encourage more efficient investment projects (Edwards 1993). The recent endogenous growth literature has reoriented the argument as to how openness enhances growth from focusing on exports to emphasizing imports of knowledge (Romer 1990, 1992; Grossman and Helpman 1991; Rivera-Baltiz and Romer 1991; Baldwin and Forslid 2000). Barro and Sala-i-Martin (1995) argue that imports give domestic producers access to a wider variety of capital goods, thus effectively enlarging the efficiency of production.

   The theories described in Grossman and Helpman (1991) suggest that the quality of intermediate products positively influences the efficiency of production. The new technology embodied in imported intermediate products renders imported products more productive and, therefore, increases labor productivity and total factor productivity (TFP). As a consequence, trade will enhance growth only to the extent that a country trades with research-intensive economies. The model of Barro and Sala-i-Martin (1995, ch. 8) considers a two-country world, where the technologically less advanced country taps into the knowledge of the technologically more advanced country. Provided that the costs of imitation are lower than the costs of innovation, the less advanced country will catch up to the more advanced country.

   Although most theories predict that growth is impeded by trade barriers, some models predict that, under certain circumstances, trade barriers may be good for growth (see, for instance, the discussion by Rodriguez and Rodrik 2000). Grossman and Helpman (1991) and Matsuyama (1992) show examples in which countries that are sufficiently far behind the technological frontier may, through imports, be driven toward production of traditional goods and, consequently, experience a lower growth rate. A closely related argument is that the host country needs a sufficiently high capacity to absorb the technology developed in the technologically more advanced countries (see, for instance, Howitt 2000). These models underscore the importance of using a sample of countries that are technologically not too far apart. The countries used in this article are quite homogenous in terms of economic development, length of schooling, and technological knowledge. We would, therefore, expect the theoretical prior to go in the direction in which trade barriers are bad for economic growth.

   Empirically, some studies find a positive relationship between growth and openness; whereas, others do not. The studies of Dollar (1992), Ben-David (1993), Sachs and Warner (1995), Edwards (1998), Vamvakidis (1998), and Frankel and Romer (1999) are well-known studies that find a negative relationship between trade barriers and growth. Studies that fail to find a negative relationship between trade barriers and economic growth are the studies of Harrison and Hanson (1999), Rodrik (1999), O'Rourke (2000), Rodriguez and Rodrik (2000), Irwin (2002), Yanikkaya (2003), and, to some extent, Vamvakidis (2002). Harrison (1996) and Rodriguez and Rodrik (2000) argue that the results are sensitive to measurement of openness and inclusion of control variables. Furthermore, Vamvakidis (2002) argues that most studies find a positive relationship between growth and openness because the estimates rely predominantly on post-1970 data. Vamvakidis (2002) shows that the positive relationship between growth and openness is limited to the post-1970 period, and that no such relationship can be found in earlier data.

3. Empirical Framework

   The empirical estimates in this article seek to be as inclusive as possible by including important control variables and time dummies that capture the effects of omitted variables that change by the same magnitude across countries over time. Furthermore, in addition to estimates covering the whole sample period, the estimation period is decomposed into three subperiods to examine whether...