Recent decades have witnessed an acceleration of economic globalisation, in particular international trade. Is trade openness the key strategy to achieve economic development? What lessons could you draw for policymaking?

One of the simplest examinations of the basis for international trade is the Ricardian Model of comparative advantage. Although this model suffers from ‘restrictive assumptions’ it does prove to be useful in outlining basic trade theory and in demonstrating the gains from trade. The model assumes that:

Labour is the only factor of production

Total amount of labour is fixed in each country

Level of technology is given for both countries and differs between them (therefore providing the single reason for productivity differences.)

Production function has constant returns to scale.

Full employment.

The model explains that free trade among countries lead to product specialisation, this increases growth and since there is only one factor of production everyone benefits from trade. Criticisms of this model are that it only considers one factor of production or ‘Leontief composite’ therefore it ‘sheds no light regarding the income distributional effects of trade….major source of protectionist demands.’ Another criticism is the fact that it doesn’t endeavour to explain what is the source for differences in comparative costs and Heckscher-Ohlin noted this point stating ‘It is a puzzle that until now so little attention has been paid to this basic issue in Ricardo’s theory of  foreign trade’. Heckscher-Ohlin were first to investigate the role of factor endowments as the basis for trade, The Factor Endowment Model was closely based on the Ricardian model. Paul Samuelson later developed and formalised the 2x2x2 model and so in the basic Heckscher-Ohlin-Sameulson model we have a world with two countries, two goods and two factors. Like the Ricardian model this assumes free trade, no transportation costs and perfect competition. In addition this model also assumes:

Production function of each good is homogenous

Technology is shared by both countries

Each good is produced with two factors of production, labour and capital

Unlike Ricardo, it assumes no technological differences between countries and more than one factor of production. Each country is endowed with different factor supplies and it is these different relative factor endowments that make relative factor prices and thus domestic prices differ across countries. The model essentially says that given that different products require different productive factors; a country will export those products that use intensively its abundant and cheap factor(s) and import those products that use the country’s scarce factor(s). Although the Heckscher-Ohlin model is usually thought to be basic for trade theory, there are many points of criticism against the model:

Factor Endowment Model: Chris Edwards, (1985) pointed out that The Factor Endowment Model applies only for most advanced countries. Frances Stewart, (1989) stated that the Heckscher–Ohlin theory is poorly adapted to evaluate South-North trade problems and that the assumptions of Heckscher–Ohlin are unrealistic in regards to North-South trade. The income discrepancy between North and South is a major concern for developing countries.

Identical production function: The model assumes that the production functions are identical for all countries concerned and this appears to be highly unrealistic. Frances Stewart, (1989) also noted that the technological gap between developed and developing countries is another key concern for the development of poor countries.

No unemployment: Yoshinori Shiozawa, (2009) believed unemployment to be a vital question in any trade conflict and as stated before the Heckscher–Ohlin theory rules out unemployment.

There are now many alternatives to the Heckscher–Ohlin model such as the New Trade Theory and the Ricardo-Sraffa Trade Theory. Even so, for now both adequately provide substantiation for the advantages of trade.

3.2 Trade openness and economic development:

   Do countries that encourage trade openness experience economic growth and in turn economic development? There exists a great amount of theoretical and empirical literature providing an affirmative answer to this question of which I will now review some of. Ghatak and Utkulu’s paper examines the impact of trade policy on the long run output growth rate in the context of the endogenous growth model by looking at the trade liberalisation experiences of Turkey, Malaysia and India since the 1950s. Each country followed different strategies to promote economic growth:

India and Turkey practiced inward-looking import-substitution industrialisation policies (ISI).

Malaysia practiced a more open export-led growth strategy.

They concluded that trade policy can affect both the short and long-run output growth rate adding that in the long run ‘the effect on output growth is jointly determined with increasing physical and human capital accumulation’. They also noted that primarily three factors determined Malaysia’s impressive economic development one of which was the increasing export orientation of the economy accompanied by the a ‘transition from an initial dependence on rubber and tin to a broadly diversified range of products’. Ghatak et al (1994) tested the export led growth hypothesis for Malaysia and their results provide support for the export led growth hypothesis, furthermore aggregate exports Granger cause real GDP and non-export GDP. However this ‘relationship is found to be driven by manufactured exports rather than by traditional exports’.  Chee Keong et al also found that the hypothesis of export-led growth in the Malaysian economy is ‘supported in both the short and long runs’. Figure 1 shows Malaysia increasingly become open and figure 2 shows that in the same period real GDP grew as well.

Figure 1 Openness measure: Malaysia

Figure 2 Real GDP (in US $): Malaysia

Extracts taken from: Trade Liberalisation and Economic Development: The Asian Experience- Turkey, Malaysia and India, Subrata Ghatak and Utku Utkulu.

There is a general belief that openness stimulates growth, Dollar, (1992), Sachs and Warner (1995), Edwards (1998) being some of the most commonly quoted studies.  According to Fischer (2000), ‘integration into the world economy is the best way for countries to grow’. He goes on to say that economic theory tells us that ‘international trade and capital flows should be to the benefit of all. Trade encourages specialisation, increasing productivity and living standards, and providing consumers with access to a wider range of better-quality goods at lower prices’.Krueger (1998), for instance, reviews that it is simple to demonstrate empirically the higher growth performance of countries with outer-oriented trade strategies. He states that the reason why trade liberalisation produces more rapid growth is because over time ISI becomes an unsuccessful strategy. So any significant amount of ‘relaxation of restrictiveness can result in gains, unless there are other policies in effect in the economy that thwart their impact’. He adds that trade liberalisation cannot nonetheless, lead to ‘sustained growth at the sorts of high rates achieved by the truly outer-oriented economies unless policy makers adopt far reaching measures that effectively provide incentives within the tradables sector at world prices and thus an outer oriented trade regime’.Stiglitz (1998) indicates a similar argument, ‘most specifications of empirical growth regressions find that some indicator of external openness, whether trade ratios or indices of price distortions or average tariff level, is strongly associated with per-capita income growth’ he then refers to Sachs and Warner (1995) for confirmation. Dollar and Kray, (2004), concluded form their paper that ‘the evidence from individual cases and from cross-country analysis supports the view that open trade regimes lead to faster growth and poverty reduction in poor countries’.

Winters (2000) asserts ‘if there is any truth in the claims that openness enhances growth, we might reasonably expect it to have beneficial effects on poverty through that route alone’. He believes that a fair assessment of the evidence is that ‘trade liberalisation alone has not been shown unambiguously to foster growth, but that it has certainly not been identified as a hindrance’. He concludes that trade liberalisation does have an encouraging role but as part of a package of ‘measure promoting greater use of the market, more stable and less arbitrary policy intervention, stronger competition and macroeconomic stability’. Though he doesn’t believe that trade liberalisation is a panacea for poverty, ‘it is absurd to pretend that liberalisation never pushes anyone into poverty, nor even that liberalisation cannot increase the extent or depth of poverty in some circumstances’.We will observe later in this paper Winters does disclose some weaknesses of trade liberalisation nonetheless.

3.3 Opposition/scepticism of trade liberalisation:

   Rodriguez and Rodrik, 1999 in their paper, reviewed four prominent papers, the papers are Dollar 1992, Ben-David 1993, Sachs and Warner 1995 and Edwards 1998. Rodriguez and Rodrik however did warn that their paper which reviews the attempts to show a link between trade openness and growth is not intended to reinforce support for the position that trade helps growth, but that the outlook for their paper is to demonstrate that there has been a tendency to greatly overemphasize the evidence in support of trade openness. They argue that ‘in many cases, the indicators of "openness" used by researchers are poor measures of trade barriers or are highly correlated with other sources of bad economic performance’. What’s more in other cases ‘the methods used to ascertain the link between trade policy and growth have serious shortcomings’.They conclude that there is little evidence that open trade policies ‘in the sense of lower tariff and non-tariff barriers to Trade’ are significantly associated with economic growth, hence development. Evidence provides no major reason to dispute the effects of trade liberalisation but what Rodriguez and Rodrik dispute is the view that ‘integration into the world economy is such a potent force for economic growth that it can effectively substitute for a development strategy’.

Winters, (2000) also pointed out some of the shortcomings of trade liberalisation:

Wage and unemployment: the Stolper-Samuelson Theorem (wherein factor supplies are fixed and wages are flexible) states that a rise in the relative price of a good that is labour-intensive in production will lead to a rise in the real wage and decrease the real returns to capital.  However Winters states ‘the theorem is not sufficient to answer questions of trade and poverty in the real world’. For instance ‘even if increases in the prices of unskilled-labour-intensive goods raise unskilled wages, poverty will be alleviated only if poor households rely largely on unskilled wage earners’. Generally developing countries are labour abundant, so that more open trade incline towards higher wages. Nonetheless, within those countries ‘it is not clear that the least-skilled workers, and thus the most likely to be poor, are the most intensively used factor in the production of tradable goods’. He adds although ‘the wages of workers with completed primary education may increase with trade liberalisation, those of illiterate workers may be left behind or even fall’.

Taxes and spending: Another concern is that trade liberalisation reduces government revenue. ‘If the compensatory increases in other taxes or decreases in expenditure impinged heavily on the poor, poverty could be exacerbated’. Furthermore Winters poses the question does trade liberalisation restricts a government's ability to manage spending and taxation in a way that impacts poverty? He argues that binding a liberalisation creates‘price-reducing effects of tariff cuts less reversible and constrains a government's ability to manipulate policy in other arbitrary ways’. Winters also mentions Rodrik, (1997) arguing that increased openness reduces government’s abilities to raise revenue due to mobile factors being unable to be taxed. 

4.0 Conclusion:

   While there are some critics of policies that encourage trade openness, there is extensive acceptance that in the long run open economies perform better than closed economies, and that comparatively open policies contribute to long run development. However many critics worry that in the short run trade liberalisation will put enormous stress on certain agents of an economy. Additionally even in the long run successful trade openness attempts may leave some lagging in poverty. Furthermore there are arguments that being open exposes an economy to shocks that generate uncertainty which may cause it to operate with higher levels of poverty than it would in a closed economy and undermines policy measures designed to lessen poverty and in turn promote development. It may also be the case that as Rodriguez and Rodrik put it, the evidence in favour of trade openness has been greatly overstated.

This paper concludes that, while care is required, open trade is generally a significant component of development policy however one cannot help but take caution in interpreting the existing evidence on the relationship between trade policy and economic growth which Rodriguez and Rodrik warned about in their paper.

   

Bibliography

Books:

Balasubramanyam, V.N and Greenaway, David- edited by, Trade and Development, St Martin’s Press Inc, 1996, Part 2: Trade Policy, chapter 6, Ghatak, Subrata and Utkulu, Utku. Trade Liberalisation and Economic Development: The Asian Experience- Turkey, Malaysia and India.

Bhagwati, N Jagdish. In Defense of Globalization, Oxford University Press, 2004, page 3.

Blaug, Mark. . 2nd Edition, Cambridge University Press, 1992, page 286.

Edwards, Chris. The Fall of The Hecksher-Ohlin Theory, The fragmented world: competing perspectives on trade, money, and crisis, London and New York: Methuen, 1985, page 29–40.

Heckscher and Ohlin. Heckscher-Ohlin trade theory, MIT Press, 1991, page 47.

Mikić, Mia. International Trade, Macmillan Press Ltd, 1998, pages 3, 4 & 54

Scholte, Jan Aart. Globalization: a critical introduction, Macmillan Press Ltd, 2000, page 14-15.

Stewart, Frances. Recent Theories of International Trade: Some Implications for the South in Kierzkowski, Henryk, Monopolistic Competition and International Trade, Oxford: Clarendon Press, 1989, page 84–108. 

Editorials/Articles:

Dollar, David and Kray, Aart. ‘Trade, Growth and Poverty’, 2004, Economic journal, 493, F22-49.

Keong, Chee Choong. Yusop, Zulkornain. Sen, Khim Liew Venus. ‘Export-led Growth Hypothesis in Malaysia: An Investigation Using Bounds Test’, 2005, Sunway Academic Journal 2, page 13–22.

http://www.scribd.com/doc/25177929/Export-led-Growth-Hypothesis-in-Malaysia-An-Investigation-Using-Bounds-Test

Krueger, O Anne. ‘Why Trade Liberalisation is Good for Growth’, September, 1998, The Economic Journal, Vol. 108, No. 450. page 1513-1522.

Rodríguez, Francisco and Rodrik, Dani. ‘Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-national Evidence’, Revised May 2000, University of Maryland and Harvard University. http://www.hks.harvard.edu/fs/drodrik/Research%20papers/skepti1299.pdf

Shangquan, Gao. ‘Economic Globalization: Trends, Risks and Risk Prevention’, 2000. Economic and Social Affairs. http://www.un.org/esa/policy/devplan/cdpbackgroundpapers/bp2000_1shangquan.pdf

Stiglitz, E Joseph. ‘Towards a New Paradigm for Development: Strategies, Policies, and Processes’, Given as the October 19th 1998 Prebisch Lecture at UNCTAD. Page 36.

http://siteresources.worldbank.org/NEWS/Resources/prebisch98.pdf

Winters, L Alan. ‘Trade Liberalisation and Poverty’, February 2000, School of Social Sciences, University of Sussex http://siteresources.worldbank.org/INTPOVERTY/Resources/WDR/winters2.pdf

Shiozawa, Yoshinori. ‘Samuelson's Implicit Criticism against Sraffa and the Sraffians and Two Other Questions’, 2009, The Kyoto Economic Review 78 (1): page 19–37.

Lectures:

Fischer, Stanley. Lunch Address given at the Conference on ‘Promoting Dialogue: Global Challenges and Global Institutions’ at American University Washington, D.C, April 13, 2000.

http://www.imf.org/external/np/speeches/2000/041300.htm

University of Essex. EC366 Lecture: Trade and Development: Inward Orientation and Outward Orientation, part 1.

http://courses.essex.ac.uk/ec/ec336/lecture_notes/xorient1.pdf page 3

Websites:

www.worldbank.org. Glossary, economic development,

[http://www.worldbank.org/depweb/english/beyond/global/glossary.html]

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