Trade Openness and Economic Growth: Empirical Evidence from Transition Economies

Abstract

Trade liberalization is often found to be key determinant of economic growth in the literature. However, in this paper we argue that the relationship between trade openness and economic growth is more ambiguous and controversial from both theoretical and empirical point of view. With regard to the latter theoretical propositions in favour of trade liberalisation rests on arguments of greater economic efficiency enhanced by lower costs of trade, lower transaction costs, increased specialisation, scale economies, and competitive pressure, which in turn foster better economic performance and increases in economic growth rates. On the other hand, it has been argued that 'passive' trade liberalisation may not necessarily lead to optimal or positive economic outcomes in the context of less (technologically) advanced economies given their limited ability to reap off the benefits of free trade including limited absorptive capabilities, pervasive market and coordination failures inhibiting development of strategic, infant or new industries, and potential ‘crowding out’ effect of trade liberalisation on domestic firms and industries. In view of this, when examining the effect of trade on economic growth it is important to control for the differences in the degree of industrial development and technological sophistication between trading countries, as well as the importance of scale economies and policy stances. As far as empirical work on the matter is concerned lot of controversies are related to methodological issues including the measurement of trade openness, methods of investigation and preferred specifications of the model. In this paper, we argue at length that measuring trade openness as the volume of export and imports as a share of total GDP may lead to misleading conclusions about benefits of trade liberalisation fostering income and economic growth. This is to say that different trade openness indicators are important to be considered when analysing the relationship between economic growth and trade, pointing to the dichotomy between trade protection and/or trade liberalisation indicators vs trade intensity and trade potential indicators, which may lead to different outcomes and policy conclusions. In light of this discussion, this paper embarks from previous literature in that i) it examines the impact of and policy implications of different trade openness indicators on economic growth in transition economies, ii) it studies the relationship between trade barriers and economic growth in transition economies that have not been previously investigated, iii) as well as it relies on different panel data estimators i.e. static and dynamic while accounting for the endogeneity issues. The empirical analysis covers Central and Eastern European transition economies in the period from 1992-2014. The results of our analysis point to the importance of specification of trade, proper treatment of the possible simultaneity bias in the relationship, and the differences in the levels of industrial and technological development across countries. Specifically, we find positive and significant impact of trade intensity indices on economic growth in CEE countries robust to different methods of investigation, model specification and sensitivity tests. However, the results of this empirical study do not render support to the hypothesis that trade liberalisation policy is beneficial to growth performance in the specific context of selected transition economies.