Abstract
AbstractThe positive association between trade openness and income has been debated over years due to serious estimation flaws prevailing in the cross-country empirical trade literature. The present paper contributes to this debate by re-examining the long-run relationship between trade openness and income per capita focusing on role of institutions. It does so by estimating a heterogeneous panel data model with 97 countries over the period 1980–2012 taking unobserved common factors into consideration. Our method is a more appropriate approach to estimate this relationship given the potential cross-section dependence and parameter heterogeneity associated with cross-country growth regressions. The results have found evidence to suggest that trade openness is positively and significantly associated with income per capita even after controlling for parameter heterogeneity, cross-section dependence and possible endogeneity. Results further suggest that better quality institutions complement the effects on in...
Highlights
Since the work, for instance by Grossman and Helpman (1990), Romer (1993), Young (1991), and Frankel and Romer (1999), a great deal of trade literature has attributed an important role to trade openness in generating economic growth, and policy-makers have continued to advocate on benefits of trade liberalization
Empirical validity of the positive association between trade openness and income has been debated over years due to serious estimation flaws prevailing in the cross-country empirical literature
We believe that our method involving common factor modeling is more appropriate in estimating trade–income association given the potential cross-section dependence and parameter heterogeneity associated with cross-country regressions
Summary
For instance by Grossman and Helpman (1990), Romer (1993), Young (1991), and Frankel and Romer (1999), a great deal of trade literature has attributed an important role to trade openness in generating economic growth, and policy-makers have continued to advocate on benefits of trade liberalization. In the presence of cross-section dependence and the fact that trade is unlikely to have homogenous impacts across countries, the results of the existing studies remain debatable for their empirical validity and interpretation. We propose an alternative approach to re-estimate the trade–income relationship with a focus on role of institutions by relaxing two major restrictive assumptions prevailing in the existing cross-country trade literature: parameter homogeneity and cross-section independence.
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