How Can One Tell if Openness to Trade Helps Economic Growth?

The nature of globalization is clearly shifting, but it’s not clear to me that the overall level is diminishing.

It does seem true the level of goods moving across international borders is rising much more slowly–or even not at all. However, the level of services being performed across international borders is rising substantially, and movements of information, data, and people are on the rise as well. But as countries around the world contemplate the possibility of disengaging from the global economy, it’s useful to ask what the consequences of such a decision would be.

In particular, does greater openness to trade improve economic growth? What evidence could you offer to make the point, one way or another? Douglas A. Irwin describes the kind of studies that have been used to address this question in the last two decades or so in “Does Trade Reform Promote Economic Growth? A Review of Recent Evidence” (World Bank Research Observer, published online April 25, 2024).

As late as the 1990s, Irwin explains, the most prominent evidence for a connection between open trade and growth was based on a method where the researcher chooses an outcome variable, like per capita GDP, and then a method of measuring the openness of the economy (explicit barriers to trade like tariffs, more subtle barriers to trade like a government-controlled exchange rate). Then, calculate whether there is a correlation between the barriers to trade and the outcome of per capita income. Of course, you can also add in some other possible explanatory variables, and control for them statistically.

This approach has some obvious problems. Correlation isn’t causation, as every econometrics course teaches. The countries that decided to open up their trade probably differed in systematic ways from the countries that didn’t do so–in particular, countries that opened up their trade probably perceived fairly near-term benefits from doing so–and also carried out a group of complementary reforms– while countries that did not open up their trade did not perceive such benefits and didn’t carry out potentially complementary reforms. When researchers looked at alternative measures of measuring openness to trade, and alternative ways of taking other possible factors into account, they often found that the results changed, as well. Also, at some baseline level, if you think about all the factors that affect growth–human capital, physical capital, technology, a rule of law, culture, infrastructure, natural resources, geographic location and others–it’s not obvious that having government change the trade rules, by itself, should have much of an effect.

Recognizing this problem, Irwin describes how researchers tried some other approaches: in particular, instead of comparing across countries, these studies often look at growth within a particular country. For example, a “synthetic control” approach looks at a country that enacted a trade reform. It then seeks a group of countries that had very similar growth patterns in the years leading up to the trade reform (and are often geographically similar to the original country), but did not carry out a trade reform. The hypothesis here is that since these countries had evolved similarly in the past, then in the absence of a trade reform, they should have continued to evolve similarly in the future. If there’s a break in the similarity at the time of the trade reform, that means something. Other studies look at firm-level data in a country: do the industries affected by greater openness to trade (and in particular, from additional foreign competition and an improved ability to buy inputs to production) do better than other industries less affected? Finally, there are detailed country-by-country case studies of trade reform.

Economists tend to mistrust any single measure of a phenomenon, but if a variety of research methods using a variety of data sources find similar results, then one’s confidence in the finding is higher. Looking at the combined results of these methods, Irwin summarizes:

The findings from recent research, however, have been remarkably consistent. For developing countries that are behind the technological frontier and have significant import restrictions, there appears to be a measurable economic payoff from more liberal trade policies. … [A] variety of studies using different measures of policy have found that economic growth is roughly 1.0–1.5 percentage points higher for countries that undertake trade reforms. Several studies suggest that this gain cumulated to about 10–20 percent higher income after a decade. The effect is heterogeneous across countries, because countries differ in the extent of their reforms and the context in which reform took place. Understanding that heterogeneity, which is sometimes attributed to labor market rigidities, financial frictions, or service-sector in puts, merits further research. At a microeconomic level, the gains in industry productivity from reducing tariffs on imported intermediate goods are even more sharply identified. They show up time and again in country after country.

Again, these results about openness to trade are focused on “developing countries that are behind the technological frontier and have significant import restrictions,” and thus less relevant to a country like the United States, which is close to the technological frontier in many areas, has only moderate import restrictions, and has a huge internal market besides. But if you are someone who worries about the power of large US corporations, and a resulting lack of competition, then pressuring these firms to face competitors from around the world whenever possible seems like a plausible response.