Relationship Between Trade Liberalization, Growth, and Balance of Payments in Developing Countries: An Econometric Study

Abstract

The objectives of this article are to study the impact of liberalization on growth, the trade deficits, and the current accounts of developing countries. It is expected that trade liberalization would promote economic growth from the supply side by leading to a more efficient use of resources, by encouraging competition, and by increasing the flow of ideas and knowledge across national boundaries. Trade liberalization could lead to faster import growth than export growth, and, hence, the supply side benefits may be offset by the unsustainable balance of payments position. This study uses panel data for 42 countries (both time-series and cross-sectional) to estimate the effect of trade liberalization on growth and growth on trade balance while controlling for other factors such as the income terms of trade. The major finding of the study is that trade liberalization promotes growth in most countries, but the growth itself has a negative impact on trade balance. Countries following trade liberalization could have high real exchange rates, a worsening savings-investment balance and consequently a worsening current account and trade balance and that this would be consistent with the rational forward looking agents in which inter-temporal budget constraints are satisfied.