Trade and Income in Asia: Panel Data Evidence from Instrumental Variable Regression

Abstract

This paper derives a Frankel-Romer instrument from a global trade matrix of 157 countries over the period 1990-2007, and deploys it to assess the relationship between international trade, domestic market potential, and income for the case of developing Asia, compared to the world average. The findings from panel instrumental variable regression confirm international trade to have caused income to rise on average across the world’s trading nations, but particularly so for countries of developing Asia, where this effect appears to be strongest. By contrast, domestic trade potential represented by country size is found to be less relevant a factor in explaining the rise in income of developing Asia. In light of a likely softening of external demand for Asian exports as global rebalancing takes hold, Asia’s underexploited domestic market potential represents considerable scope for the region to step up its efforts to gradually reinforce the domestic and regional dimensions as an additional engine of growth.