Openness and development

Tim and Jim are having a good set-to about the link between trade liberalization and development. It started when Jim objected to Stephen Pollard’s claim that: “The engine of growth, without which countries remain in poverty, is trade. Tariff protection keeps resources in unproductive low-return activities.”

Jim replies:

If he is right that trade liberalisation is the road to riches, wouldn't we expect the Third World region with the most liberalised trade policy to be the richest? But which one is the most liberalised? According to the World Bank, that would be sub-Saharan Africa.

Tim retorts that tariff barriers understate the barriers to trade in Africa; the problems there, he says, are bad transport and corrupt tax systems.

My take is that both Jim and Tim are right.

Jim’s right to reject the simple view that trade creates growth. The empirical evidence is weaker than you might think. Dani Rodrik’s classic paper (big pdf) concludes:

We are skeptical that there is a strong negative relationship in the data between trade barriers and economic growth…the search for such a relationship is futile.

More recent research by Roberto Rigobon has challenged this. But even this has merely shown that you need immense econometric spadework to find only a weak link.

There are two reasons for this lack of a robust relationship. One is that it is not necessarily the case, as Tim claims, that “it is trade, with the associated playing out of comparative advantage and the division of labour, that makes places rich.”

It’s theoretically possible that free trade would lead a poor country to specialize in industries requiring unskilled labour. If these are industries with poor growth prospects, such an open economy might well grow slowly. (This raises the question: what exactly are the links between allocative efficiency and fast growth?)

The second reason – and I think the more important one - is that it is not a closed economy per se that depresses growth, but rather all the things that are often but not always correlated with being closed. Once you control for these, the link between openness and growth weakens.

It’s here that Tim is spot-on. Bad transport or corrupt tax systems can both depress growth and cause economies to be closed. In such cases, low tariff barriers won't do much good. There are other examples.

A country might be closed because a dictatorial government discourages links with the outside world. North Korea is a poor closed economy. But it’s poor mainly because of a crap government, not merely because it’s closed.

Anything that depresses investment – lack of confidence, low education, insecure property rights, bad capital markets – will cause low imports of capital goods. In the data, it will look as if a closed economy (in the sense of a low import-GDP ratio) leads to slow growth – but again, the causal link is different.

Examples like these mean that if a government can provide secureish property rights, good education and confidence, it could get good growth even with tariff barriers - as China and India have shown. And conversely, a country with low tariff barriers but no other pro-growth factors in place won't grow.

So, maybe it’s not trade in itself that matters for growth, but rather the attitudes that generate trade – sound property rights, an interest in the outside world (including a willingness to attract FDI), and good government. As Roberto Rigobon put it: “It is openness in a broad sense – as part of the overall economic, policy, and institutional environment – that is conducive to growth.”

I’ll leave you with a question. Why do we need single simple big ideas here? Why look for a “one size fits all” strategy? In this paper (pdf) Dani Rodrik says we should abandon such ideological pretension, and just ask: what exactly is the main bottleneck stopping this particular country from growing? What’s wrong with this?

Another thing: If you accept the view that there's no link between tariff barriers and growth, it does not follow that you should support trade restrictions. There's a world of difference between believing tariff barriers in general don't retard growth, and believing that a particular tariff on a particular product will do positive good.

Comments

[Tim Worstall]

Chris,
I might not have been clear enough in this line:
“it is trade, with the associated playing out of comparative advantage and the division of labour, that makes places rich.”
I meant that to not refer excelusively to cross border trade, but to trade in general, even it’s me swapping my carrots for his broad beans with the guy next door. On that level I’m not sure that there can be disagreement.

[Chris]

If we're being mega-pedantic, I'd rather this read: "it is trade, with the associated playing out of comparative advantage and the division of labour, that makes people as rich as they can be, given their factor endowments." This leaves open the question of whether trade or tariffs are the best way to develop factors - that is, whether "infant industry" arguments have any weight. (I don't think they often do). Someone who is an unskilled numbskull won't get rich through trade - they'll have to go into government instead.

[Andrew Duffin]

Wasn't it Adam Smith who said that all you need, for a country to improve from squalor to glory, is property rights, low taxes, and the rule of law? (Or some paraphrase of that). I've always thought he was pretty much spot-on; it sounds as if you agree.