Trade Openness Raises Economic Growth

Summary of working paper 5978

More open countries...have experienced faster productivity growth throughout the decades 1960 to 1990.

As rhythmic as the tide, every four years politicians rekindle the debate over trade policy. Is there a correlation between trade policy and economic performance? Do protectionist policies ensure growth or is it free trade that promotes rapid growth?

The trade policy debate is hardly new, NBER Research Associate SebastianEdwards suggests in Openness, Productivity and Growth: What Do We Really Know? (NBER Working Paper No. 5978). Yet despite more than a century of controversy, skeptics argue that the effect of openness on growth is still tenuous. However, Edwards points out that recent gains in aligning theoretical models with actual patterns of economic growth, and the availability of more comprehensive datasets, reinforce the notion that openness does, indeed, spur economic growth.

Edwards notes that past studies have suggested that countries that are more open to the rest of the world are better able to absorb the rapid technological advances of leading nations. If the costs of technological imitation are lower than the costs of internally developed innovations, then a poorer country will grow faster than a more developed one. This faster rate of growth will continue so long as that country remains open to capturing new ideas until, at some point, an equilibrium is reached and the rate of growth slows.

Edwards uses a new comparative dataset for 93 countries to analyze the relationship between openness and total factor productivity (TFP) growth. He notes that past limitations in appropriate comparative measures of openness have left studies on the relationship between openness and productivity open to question. To bolster his case, he uses nine alternative indexes of trade policy.

Edwards finds that more open countries indeed have experienced faster productivity growth, and that result holds true no matter which openness index he uses. He further finds that his results are not specific to a certain period, but apply generally throughout the decades 1960 to 1990.

Edwards separately analyzes property rights, political instability, and macroeconomic instability as determinants of TFP growth that may have been left out of earlier work. Although property rights explain some of the cross-country differences in productivity growth, the relationship between openness and economic growth is not affected by these variables.