Openness, Productivity and Growth: What Do We Really Know?

Abstract

Comparative data for 93 countries are used to analyse the robustness of the relationship between openness and total factor productivity growth. Nine indexes of trade policy are used to investigate whether the evidence supports the view that total factor productivity growth is faster in more open economies. The results are robust to the use of openness indicator, estimation technique, time period and functional form, and suggest that more open countries experienced faster productivity growth. Although the use of instrumental variables help dealing with endogeneity, issues related to causality remain somewhat open, and require time series analyses to be adequately addressed. Old controversies die slowly. For over a century social analysts have debated the connection between trade policy and economic performance. While according to liberal economists freer trade results in faster growth, some analysts have argued that protectionism may help economic performance. This controversy continues today, even as the world is experiencing an unprecedented period of trade liberalisation, and in spite of numerous empirical studies that claim to have found a positive effect of openness on growth. The most prominent trade liberalisation sceptics include Krugman (1994) and Rodrik (1995), who have argued that the effect of openness on growth is, at best, very tenuous, and at worst, doubtful. Two issues have been at the core of these controversies: first, until recently theoretical models had been unable to link trade policy to faster equilibrium growth. And second, the empirical literature on the subject has been affected by serious data problems.1 During the last decade, however, the 'new' theories of growth pioneered by Romer (1986) and Lucas (1988) have provided persuasive intellectual support for the proposition that openness affects growth positively. Romer (1992), Grossman and Helpman (1991) and Barro and Sala-i-Martin (1995), among others, have argued that countries that are more open to the rest of the world have a greater ability to absorb technological advances generated in leading nations. Barro and Sala-i-Martin (1995, Ch. 8), for example, consider a twocountries world (one advanced and one developing), differentiated inputs, and no capital mobility. Innovation takes place in the advanced (or leading) nation, while the poorer (or follower) country confines itself to imitating the new techniques. The equilibrium rate of growth in the poorer country depends on the cost of imitation, and on its initial stock of knowledge. If the costs of imitation are lower than the cost of innovation, the poorer country will