Developing Countries, Trade Openness and...

Developing Countries, Trade Openness and Growth

Arvind PanagariyaColumbia University

DEC Lecture, World BankFebruary 16, 2011

2

What are the Goals of Policy?

• Poverty– Country-wide, rural, urban, specific castes, tribes

• Human Development Indicators (HDI)– Life expectancy, mortality (Infant, child, adult),

nutrition, literacy, education enrolment ratios, …• Inequality

– Country-wide, regional, rural-urban, rich-poor gap, skilled-unskilled wages, gender gap, across castes

• Other Social Goals– Labor rights, environment, reduced farmer suicide rates

3

Orderly Discussion Requires Narrowing Down the Scope

• Not all goals are equal– Within limits, poverty and some HDI take precedence

over inequality and many other goals

• Multiple goals require the deployment of multiple instruments

• For the discussion today, the focus is exclusively on growth: it is not a cure all solution to achieve various goals but it is the single most important one for the poor countries

4

Why is Growth the Most Important Instrument?

• Growth impacts outcomes through two avenues– The “Pull-up” Effect: Provides gainful employment

improving poverty and some HD outcomes (Korea and Taiwan: 1960s and 1970s; India and China: more recently)

– The Revenue Effect: Enhanced revenues for social programs on larger scale (India: NREGS, education, health)

• Redistribution by itself has serious limits in poor countries (Pre-1980s China and India; Least Developed Countries)– There is not enough income to redistribute– Poor governance makes the implementation of redistribution

policies and social programs difficult

5

Korea: GDP Shares

Year

Agriculture, forestry and

fisheries MiningManufact

uring Other

1960 36.9 2.1 13.6 47.41965 38.7 1.8 17.7 41.81970 25.8 1.3 21 51.91975 24.9 1.4 26.6 47.11980 15.1 1.4 30.6 52.91985 13.9 1.5 29.2 55.31990 9.1 0.5 29.2 61.2

6

Korea: Employment Shares

Year

Agriculture, forestry and

fisheries MiningManufact

uring Other1960 68.3 0.3 1.5 29.91965 58.6 0.9 9.4 31.11970 50.4 1.1 13.1 35.41975 45.7 0.5 18.6 35.21980 34 0.9 21.6 43.51985 24.9 1 23.4 50.71990 18.3 0.4 26.9 54.4

7

Korea: Growth in the Real Wages

Year Growth in Real Wages1961 4.81962 11963 -5.41964 -61965 4.31966 6.21967 11.31968 16.51969 22.21970 9.81971 2.71972 2.21973 14.9

8

Therefore, the Focus of the Talk TodayFree Trade and Growth

9

Use of the Term “Free Trade”

• Not to be taken literally• No examples of complete free trade in the world—

even Hong Kong has restrictions in the area of trade in services

• The term is to be interpreted as representing– a state of low protection or – movement from higher to lower protection in

conjunction with appropriate adjustment in the exchange rate.

10

The Asymmetric Terms of the Debate between the Proponents and Opponents

• Frédéric Bastiat (1848) best stated this in the preface to the Economic Sophisms:

“But, it may be asked, are the benefits of freedom so well hiddenthat they are evident only to professional economists?

“Yes, we must admit that our opponents in this argument have a marked advantage over us. They need only a few words to set forth a half-truth; whereas, in order to show that it is a half-truth, we have to resort to long and arid dissertations.

“This situation is due to the nature of things. Protection concentrates at a single point the good that it does, while the harm that it inflicts is diffused over a wide area. The good is apparent to the outer eye; the harm reveals itself only to the inner eye of the mind.”

11

160 Years Later, the Asymmetry Persists

• The standard of proof the proponents must meet is significantly higher than the one expected of the opponents.

• Proponents must establish not just the preponderance of evidence on their side but causation based on the latesteconometric standards that are themselves rising over time.

• The opponents only need– Poke a few holes in the studies by the proponents– Point to the damage and dislocation done by liberalization– Assert claims of success of infant industry protection et al.– Declare victory

• To-date: No attempt by the opponents to causally link high or rising protection to rapid growth and poverty alleviation.

12

Setting the Bar Right: What the Proponents Need to Demonstrate

• Proposition 1: Low or declining barriers to trade, which frequently reflect themselves in a high or rising trade-to-GDP ratio, are necessary for sustained rapid growth.

• Proposition 2: Low or declining barriers to trade are not behind stagnation or declining incomes of countries.

• These propositions are sufficient to establish low or declining trade barriers as the preferred policy over high or rising protection.

13

What about the Sufficiency of Free Trade for Sustained Rapid Growth?

• It should be obvious that trade liberalization will not always lead to sustained rapid growth. For example, it will end up having zero impact if– The external markets are closed– Transport network linking production hubs to ports is missing– Domestic product or factor market policies straitjacket the

economy so as to rob it of all supply response• To choose between (i) low or declining protection and (ii) high

or rising protection, we only need to know– Which of them promise the superior outcome and– Which of them are generally a part of the policy packages followed

by countries experiencing sustained rapid growth

14

Various Forms of Evidence

I. Aggregate evidence Over Time: Overall growth experience of the developing countries during various phases over the last forty-five years (1961-2005) for which we have the data

II. Cross-country evidence– Miracles and Debacles– Regressions aimed at establishing causation

III. Country case studies

15

I. Aggregate Evidence

1960-80: The Golden Age?

• Free-trade critics (Rodrik, 1999, Chang 2007)– 1960-75 represents the “Golden Age” of development

with the developing countries growing faster than in any other period

• It is also characterized by import-substitution industrialization (ISI) in the developing countries

• Two issues with these assertions– Is the claim on growth factually true?– Were the fast-growing countries indeed pursuing

import-substitution policies during this period?

16

I. Aggregate Evidence over Time

Growth Rates: The Reality Check

Period DevelopingHigh Income

OECD1961-75 2.7 3.61976-90 1.7 2.61991-05 3.5 1.7

1961-73 2.8 4.21974-90 1.8 2.31991-2007 3.9 1.8“Developing” includes the developing countries in Asia, Latin America and Sub-Saharan Africa

17


Alternative Cutoff Dates

Period DevelopingHigh Income

OECD1961-70 2.6 4.21971-80 3 2.61981-90 1 2.51991-2000 3.2 1.92001-07 4.8 1.6

1961-80 2.8 3.41981-2007 2.8 2.2

“Developing” includes the developing countries in Asia, Latin America and Sub-Saharan Africa

18


Two Facts Stand Out

• No matter how we slice the 45-year period, the performance in the developing countries in the post-1990 period far outdid that in any other period

• The superior performance of the developing countries during the post-1990 period has taken place in the face of relatively low growth in the high-income OECD countries suggesting the developing country policies themselves as the driver of that growth

19


Import Substitution or Outward Orientation?

• By far the most successful countries during the 1960s and 1970s—South Korea, Taiwan, Singapore and Hong Kong—did not follow the ISI strategy during this period.

• Even Brazil, which grew 8.3% annually on per-capita basis 1969-75, saw its exports grow 11% per year during the same period. Brazil also saw trade barriers decline and domestic currency depreciate in real terms during this period.

20

II. Cross-country Evidence

A More Comprehensive Look at the Data

• Define– Miracle: Annual per-capita-income growth of 3

percent or more over a 15-year period– Debacle: Zero or negative growth in per-capita

income over a 15-year period • Questions

– Are miracles associated with trade expansion?– Are debacles associated with import surges?

21


Summary of Miracle Countries

Period

Miracle Countries

(3% or Higher Per-

capita Growth)

Miracle Countries

with Rising Exports to GDP Ratio

Percent of Developing

Country Population in

Miracle Countries

1961-75 21 19 151976-90 22 15 44.81991-2005 34 27 65.2

22


Summary of the Debacle Countries

*In additional six cases, the import growth figure is missing but these are predominantly oil exporting countries

Period

Debacle Countries

(Stagnant or Declining Per-capita Income)

Debacle Countries

with Import Growth

Exceeding 5%

Percent of Developing

Country Population in Debacle Countries

1961-75 6 1 3.71976-90 38 4* 17.41991-2005 23 8 9.1

23


The Causation Issue

• Critics claim reverse causation: GDP growth causes trade growth.

• Four responses– (i) Critics have provided no evidence in favor of their

hypothesis– (ii) Low or declining barriers to trade are a part of

almost all rapid-growth stories– (iii) If trade expansion is the objective, will it be

facilitated by higher or lower protection?– (iv) There now exists compelling regression-based

evidence linking trade causally to per-capita GDP

24


Causation: (i) Challenging the Critics

• Critics argue that the GDP growth increases the demand for imports, which requires growth in exports through the balance-of-trade condition

• Generally, rapid GDP growth accompanies a rise in the trade-to-GDP ratio, not just growth in trade

• This implies that if the GDP growth is the sole driver of trade, it must be biased in favor of imports over domestic products

• Critics have produced NO evidence showing this

25


Causation: (ii) Declining Barriers an Integral Part of High-growth Stories

• Country case studies overwhelmingly demonstrate that sustained rapid growth in incomes is always accompanied by either low or declining barriers to trade complemented by significant depreciation of the domestic currency

• Not all liberalization is accompanied by sustained rapid growth but almost all sustained rapid growth is accompanied by increased liberalization unless protection is already low

26


Causation: (iii) Will Increased or Reduced Protection Lead to Faster Growth in Trade?

• We must ask: If faster growth in trade is an integral part of the rapid-GDP-growth story, will we enhance the prospects of growth by reduced or increased barriers to trade?

• Think of the flow of water running in a tap. As water pressure increases, is water flow going to be enhanced by opening or closing the tap? As growth increases the pressure on imports, will import expansion be facilitated by increased or reduced import barriers?

• Like a tightly closed tap, which kills water flow no matter how high the pressure, autarkic policies kill imports. India in the 1960s and 1970s shows how autarkic policies can scuttle growth impulses while Korea shows the opposite.

27


Causation: (iv) Econometric Studies

• Two broad approaches– Relate trade barriers (tariff and non-tariff

measures) to per-capita income or growth– Relate trade flows to growth or per-capita

income• Issues of two-way causation plague both

sets of variables, especially the latter

28

II. Cross-country EvidenceCausation: (iv) Econometric Evidence (continued)

• Trying to connect trade policies to growth proves problematic because – (i) Converting a set of tariffs into a single aggregate

measure of protection for regression in a way that is comparable across countries is fraught with problems;

– (ii) Worse problems characterize non-tariff barriers;– (iii) The absence of complementary policies

(overvalued exchange rate, domestic regulation, infrastructure) may scuttle trade response to liberalization—a feature not easily captured by simple linear regressions.

– (iv) Two-way causation cannot be ruled out

29


• Therefore, Frankel and Romer (1999) and Frankel and Rose (2002) choose to establish the causation by (i) separating the component of trade that depends only on distance and country size and not on income and (ii) relating it to per-capita income.

• This approach has yielded quite convincing evidence of causation running from trade to per-capita incomes.

• Frankel and Rose (2002) overcome every one of the objections raised by critics.

30


• Rodriguez and Rodrik (2000) and Rodrik (2000) had raised several objections to Frankel and Romer (1999) and to an unpublished version of Frankel and Rose (2002).

• In the published version, Frankel and Rose (2002) successfully overcame every one of those objections.

31


“Still, the key question concerns the implications of these perturbations [pointed out by Rodriguez and Rodrik (2000) and Rodrik (2000)] for the openness variable. In every case, regardless of whether the other controls are included or not, the openness variable retains most of its magnitude and all of its statistical significance in the presence of each of the three Rodriguez-Rodrik modifications. The t-statistics are 3 to 4.” (Frankel and Rose, p. 451, emphasis in the original)

32


• Rodriguez and Rodrik (2000) are left with just one assertive criticism (since they provide no evidence supporting it):– The “implications of geography-induced differences in trade, on

the one hand, and policy-induced variations in trade, on the other, can be in principle quite different.”

• But Frankel and Rose counter even this criticism. They separately estimate the effects of openness on per-capita income when (i) all trade measures openness and (ii) only distance and size induced trade measures it. They do not reject the hypothesis that the two estimates are equal. The two types of trade, thus, have the same effect on incomes.

33

II. Cross-country EvidenceWhat Positive Evidence have the Critics Offered in Support of their Position? (No t-statistics reported!)

Rodrik, Dani: “Trading in Illusions,”Foreign Policy, May/April 2001

34

III. Country Case Studies

Success Stories

• Singapore, Hong Kong• South Korea• Taiwan• China• India• Chile• Vietnam

35

Taiwan: Summary Growth Rates

Period

Annual GDP

Growth Rate

Annual Per-capita GDP

Growth Rate

1951-53 to 1961-63 7.02 3.761961-63 to 1971-73 10 7.281951-53 to 1971-73 8.5 5.5

36


Taiwan: Growth rates by Year

Year

GDP Growth

Rate Year

GDP Growth

Rate1952 12.0 1963 9.41953 9.3 1964 12.21954 9.5 1965 11.11955 8.1 1966 8.91956 5.5 1967 10.71957 7.4 1968 9.21958 6.7 1969 9.01959 7.7 1970 11.41960 6.3 1971 12.91961 6.9 1972 13.31962 7.9 1973 12.8

37


Taiwan: The Rise of Manufactures Exports

YearTotal ($Million)

Agricultural ($Million)

Non-agricultural ($Million)

Percent Growth in Agricultural Exports

Growth in Non-agricultural Exports

1952 119.5 114.2 5.31953 129.8 121.2 8.6 6.1 62.31954 97.8 90.8 7 -25.1 -18.61955 133.4 124.4 9 37.0 28.61956 130.1 114.9 15.2 -7.6 68.91957 168.5 155.4 13.1 35.2 -13.81958 164.4 145.6 18.8 -6.3 43.51959 160.5 128.4 32.1 -11.8 70.71960 169.9 121 48.9 -5.8 52.31961 214 131.9 82.1 9.0 67.91962 238.6 129.4 109.2 -1.9 33.01963 357.5 218.2 139.3 68.6 27.61964 463.1 277.6 185.5 27.2 33.21965 487.9 286 201.9 3.0 8.8

38


Taiwan: The Real Effective Exchange Rate for Exports

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

Real Effective Excahnge Rate for Exports (NT$/U.S. Dollar)

1959 1967 1974

39


Taiwan: Shift to Labor-intensive Exports

Item 1952 1955 1960 1965 1970 1975Food, beverages and tobacco preparations 83.6 84.6 58.5 39.1 9.4 7.3Textiles, Leather, Wood, paper and related Products 0.9 2.4 17.1 26.2 30.3 24.4Non-metallic mineral products 0.0 0.0 1.8 3.1 2.5 0.6Chemical and pharmaceutical products 3.5 3.3 4.9 4.4 1.8 2.0Basic metals 0.9 1.6 3.7 3.6 3.2 1.5Metal products 0.0 0.0 0.6 1.1 1.4 1.6Machinery 0.0 0.0 0.0 1.3 2.3 2.4Electrical machinery and apparatus 0.0 0.0 0.6 2.7 8.8 9.6Transportation equipment 0.0 0.0 0.0 0.4 0.6 1.4Others 11.2 8.1 12.8 18.0 39.8 49.2Total 100.0 100.0 100.0 100.0 100.0 100.0

40


Korea: Annual Average Growth Rates

PeriodGDP Growth

Per‐capita GDP Growth

Exports of goods and services

Imports of goods and services

By Economic Criteria1954‐62* 4.2 1.3 13.9 5.21963‐73 9.1 8.5 32.1 21.41974‐82 6.9 5.1 14.0 12.21983‐95 8.7 7.6 12.6 13.51996‐2008 4.4 3.8 12.4 8.5By Decades1954‐60* 4.3 1.2 10.4 3.41961‐70 8.3 7.7 29.0 20.51971‐80 7.3 5.4 21.7 15.51981‐90 8.7 7.5 11.2 11.21991‐2000 6.2 5.2 15.6 11.82001‐08 4.4 3.9 10.0 8.3

41


Korea: Rise of Manufactures Exports

Year

Total Exports ($Million)

Primary Products ($Million)

Manufactures ($Million)

Growth in Primary Products

Growth in Manufactures

1961 42.9 33.5 9.4 60.81962 56.7 41.4 15.3 23.6 62.81963 84.4 40.8 43.6 -1.4 185.01964 120.9 58.6 62.3 43.6 42.91965 180.5 68.1 112.4 16.2 80.41966 255.8 96.1 159.7 41.1 42.11967 358.6 107.4 251.2 11.8 57.3

42


Korea: Shift to Labor-intensive Exports

YearTotal

Exports Plywood

Cotton Fabrics Woven

Plates & Sheets of Iron and

Steel

Electrical Machinery

and Apparatus Clothing

Footwear

Wigs & Human

Hair1961 42.9 2.8 2.1 1.2 0.0 0.0 0.0 0.01962 56.7 4.1 3.2 0.9 0.2 1.9 0.4 0.01963 84.4 7.5 5.1 9.8 1.1 5.5 0.8 0.01964 120.9 9.4 9.2 1.7 1.3 5.5 0.7 0.21965 180.5 10.0 5.8 5.7 1.8 11.5 2.3 1.31966 255.8 11.7 3.9 2.8 3.2 13.1 2.2 4.71967 358.6 10.2 3.5 0.3 2.6 16.5 2.3 6.31968 500.4 13.1 2.7 0.2 4.4 22.4 2.2 7.01969 702.8 11.3 2.6 0.5 6.0 22.9 1.5 8.61970 1,003.90 9.1 2.6 0.8 4.8 21.3 1.7 10.11971 1,352.00 9.2 2.3 1.5 5.5 22.5 2.8 5.21972 1,807.00 8.5 1.9 3.8 7.6 24.5 3.1 4.11973 3,254.20 8.3 1.7 4.0 10.6 23.0 3.3 2.5

43


Korea: Real Effective Exchange Rates for Exports

Real Effective Exchange Rate for Exports (constant-price won per dollar)

0

50

100

150

200

250

300

350

1955

1956

1957

1958

1959

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

44


India: GDP and Per-capita GDP Growth

4.1

3.23.6

4.6

5.8

8.3

2.0

1.01.5

2.3

3.8

6.8

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1951-65 1965:81 1951-81 1981-88 1988-2003 2003-10

GDP Per-capita GDP

45


India: Evolution of the GDPGDP at Factor Cost (Billion 1999-2000 Rupees)

0

5000

10000

15000

20000

25000

30000

35000

40000

1950

-51

1953

-54

1956

-57

1959

-60

1962

-63

1965

-66

1968

-69

1971

-72

1974

-75

1977

-78

1980

-81

1983

-84

1986

-87

1989

-90

1992

-93

1995

-96

1998

-99

2001

-02

2004

-05

2007

-08

GDP at Factor Cost (Billion 1999-2000 Rupees)

GDP Growth Rates

Phase I: 4.1% Phase II: 3.2% Phase III: 4.6% Phase IV: 5.8%

Phase V: 8.5%

46


India: Imports and Total Trade in Good and Services (as% of the GDP): 1950-2009

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1950

-51

1953

-54

1956

-57

1959

-60

1962

-63

1965

-66

1968

-69

1971

-72

1974

-75

1977

-78

1980

-81

1983

-84

1986

-87

1989

-90

1992

-93

1995

-96

1998

-99

2001

-02

2004

-05

2007

-08

Imports of Goods and services as % of GDP Trade in Goods and services as % of GDP

1969-70: 4.1%

1957-58 1991-92 2001-02

47


China: Annual GDP and Per-capita GDP Growth Rates

9.3

10.510.0

7.7

9.3 9.4

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1981-90 1991-2000 2001-09

Annual GDP Growth Rate Annual Per-capita GDP Growth Rate

48


China: Exports and Total Trade in Goods and Services as % of the GDP

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

% o

f GD

P

Exports of Goods and Services/GDP Trade in Goods and Services/GDP

49


China: Comparison of the Share in the World Merchandise Exports with USA

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

China's Merchandise Exports as % of the WorldUSA's Merchandise Exports as % of the World

50

The Specious Arguments by Critics

(i) Trade Liberalization has Failed to Catalyze and Sustain Growth in Many Instances

(ii) Trade did not Catalyze Many Growth Miracles(iii) High Protection does not Preclude Rapid

Growth(iv) Import Substitution has Preceded Outward

Orientation(v) Most Successful Countries have Deployed

Industrial Policy

51

(i) Trade Liberalization has Failed to Catalyze and Sustain Growth in Many Instances

• We can point to even larger number of examples of countries failing to stimulate growth through protectionism

• No serious trade economist offers free trade as the cure all formula to overcome stagnation. External or internal conflict, lack of policy credibility, macroeconomic instability, overvalued exchange rate, product- and factor-market rigidities and poor infrastructure may conspire to block the benefits of an open trade regime from being realized.

52

(ii) Trade did not Catalyze Many Growth Miracles

• Critics argue that accelerated growth was catalyzed by– Land reform in the case of China (Bardhan)– Government-engineered investment coordination in South Korea

and Taiwan (Rodrik)– “Change in the attitudes of government officials” in the case of

India (Rdorik and Subramanian)

• Problems with the argument– Trade liberalization was at least a partial catalyst in all these cases– Even if we reject this claim, rapid growth has been sustained over

a long period by knocking down trade barriers in all cases: Korea, Taiwan, Singapore, China, India, Chile and Vietnam.

53

(iii) High Protection does not Preclude Rapid Growth

• Critics cite: India and China in the 1980s, Brazil in the 1960s.

• True, high initial trade barriers do not preclude the onset of rapid growth, especially in countries such as Brazil, China and India that have large internal markets. But growth sustains and accelerates only if the country responds by liberalizing and accommodating the necessary expansion of trade

54

(iv) Import Substitution has Preceded Outward Orientation

• Examples: Taiwan and Korea in the 1950s, India and China afterwards

• Problems– Hong Kong offers a counterexample– In the cases cited above, the necessity of import

substitution for the subsequent success is disputable– Most importantly, with forty to sixty years elapsed

since the end of the colonization, the argument has no salience today

55

(v) Most Successful Countries have Deployed Industrial Policy

• Critics downplay outward-oriented policies arguing that most successful countries relied on industrial policy including targeting of certain industries (Amsden, Wade)

• The presence of industrial policy, itself a separate subject of debate, cannot prove either the beneficial or harmful impact of openness on growth

• Depending on one’s stance in industrial policy, One can plausibly argue that the low or declining trade barriers either minimized the damage from industrial policies or maximized the benefits from them in countries such as South Korea.

56

The Infant Industry Argument for Protection

• No conceptually tight case for protection (as opposed to some other form of intervention) has been produced to-date. After forty years, Baldwin (1969, p. 303) remains still true:– “If the infant-industry argument for tariff protection is

worthy of its reputation as the major exception to the free-trade case, it should be possible to present a clear analytical case, based upon well-known and generally accepted empirical relationships unique to infant industries, for the general desirability and effectiveness of protective duties in these industries. The contention of this paper is that such a case cannot be made.”

57

The Infant Industry Argument for Protection (Continued)

• Rodrik (2006) concedes when he says:– “What I understand by ‘industrial policy’ is not an

effort by the government to select particular sectors and subsidize them through a range of instruments (directed credit, subsidies, tax incentives, and so on). The critics of industrial policy are correct when they argue that governments do not have adequate knowledge to pick ‘winners.’”

• But Rodrik (2007) resurrects protection as one of the remedies to correct the externality associated with the discovery of new products and lower-cost methods of production of existing products but without rationale.

58

The Infant Industry Argument for Protection (Concluded)

• Chang (2007) makes the argument more frontally but without offering either conceptual foundations or empirical link between protection to the infant and its success. His arguments amount to little more than the post-hoc fallacy.

• Greenwald an Stiglitz (2006) supposedly formalize the argument but it too fails close scrutiny, unable to overcome the problems pointed out by Baldwin (1969).

Developing Countries, Trade Openness and...

Documents

Transcript of Developing Countries, Trade Openness and...