Chapter 6: Institutions and Trade: Competitors or Complements in Economic Development
6.1 THE BACKGROUND The empirical relationship between trade and development at the crossnational level has been a topic of research for several decades now. Many policymakers argue that trade openness is beneficial for growth. Outward orientation of a country promotes efficiency amongst the local firms and also facilitates technology transfer. Both of these are good for growth. The root causes literature has reinvigorated the debate over the effectiveness of policy and trade policy, in particular, in promoting growth. Until recently, it appeared that a growing academic as well as policy consensus was emerging on the positive effects of trade on development. Dollar (1992), using an ‘index of real exchange rate distortion’ and an ‘index of real exchange rate variability’, shows that outward orientation is good for economic growth. Sachs and Warner (1995a) construct an index that combines all aspects of trade policy and show that countries with an open trade regime, on average, perform better than countries with closed trade regimes. Ben-David (1993), on the other hand, shows that trade liberalization leads to less dispersion in income across countries and hence convergence. In another influential study, Frankel and Romer (1999) show that there is a positive relationship between trade volume and national income to the extent that an increase in trade volume is the result of a reduction in natural or geographical barriers to trade rather than trade policy. They use the geographical component of trade volume as an instrument to identify the effects of trade on income. In the...
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