Trade liberalization, Openness and Growth

Table of Contents

1. The gains from trade........................................................................................................................21.1 Comparative advantage in Ricardo’s model..............................................................................21.2 Comparative advantage with two factors: Heckscher-Ohlin......................................................5

1.2.1 Concepts..............................................................................................................................51.2.2 Measurement.......................................................................................................................61.2.3 Do countries specialize or diversify ?.................................................................................8

1.3. Monopolistic competition and product variety.......................................................................111.3.1 Homogenous firms............................................................................................................111.3.2 Heterogeneous firms.........................................................................................................13

2. The openess-growth debate from the ’95 until today.....................................................................142.1 Trade liberalization in a Solow model.....................................................................................142.2 The « East Asian Miracle »......................................................................................................152.3 The cross-sectional evidence....................................................................................................17

2.3.1 Trade openess index of Sachs-Warner..............................................................................172.3.2 The critique of Rodriguez et Rodrik.................................................................................21

2.4 The evidence in panel...............................................................................................................223. Structural adjustment and resource allocation...............................................................................32References..........................................................................................................................................34

List of tables

Table 1: Productivity and endowment data in a Ricardian example....................................................3Table 2: candidate equilibrium for the integrated world economy......................................................4Table 3: Estimated TFPG in the East Asian Miracle.........................................................................16Table 4: Estimation results of Young (1993).....................................................................................17Table 5: Growth and openness: Cross-section regression results 1980-90........................................19Table 6: TFP growth regressions with various openness indices.......................................................20Table 7: Regression results of Rodrik Rodriguez with the decomposed SW index..........................21Table 8: Trade liberalization dates in Wacziarg and Welsh...............................................................23Table 9: Details of trade reforms by country.....................................................................................23Table 10: SW results reproduced.......................................................................................................24Table 11: SW results on a different time period................................................................................25

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Table 12: Growth and openness in panel...........................................................................................26Table 13: Growth regressed in the liberalization indicator................................................................30Table 14: Growth regressed on tariff changes...................................................................................30Table 15: Approach 1 with instrumental variable..............................................................................31

List of figures

Figure 1: Production Possibility Frontier and autarky equilibrium : Portugal.....................................3Figure 2: Production Possibility Frontier and autarky equilibrium : Great Britain.............................3Figure 3: The gains from trade.............................................................................................................4Figure 4: The gains from specialisation...............................................................................................4Figure 5_ Factor Endowment and PPF: The Rybczynski Theorem.....................................................5Figure 6: Factor Endowment and Comparative Advantage: The Heckscher-Ohlin Theorem.............5Figure 7: Factor endowments and revealed factor intensities..............................................................7Figure 8: Comparative advantage and the survival of exports.............................................................7Figure 9: Fuel exports and GDP volatility...........................................................................................8Figure 10: Export concentration and the level of income....................................................................9Figure 11: Concentration: Individual country trajectories...................................................................9Figure 12: The export re-concentration at high levels of income........................................................9Figure 13: What are the closing export lines?....................................................................................10Figure 14: Effect of an increase in the custom duty rate on capital equipment in the Solow model.14Figure 15: Average growthe for closed and open economies............................................................17Figure 16: convergence among closed economies.............................................................................18Figure 17: Convergence among open economies..............................................................................18Figure 18: Growth and import tariffs.................................................................................................22Figure 19: Growth and NTB coverage ratios.....................................................................................22Figure 20: Time profile of growth around liberalization year...........................................................27Figure 21: Time profile of investment around the liberalization year...............................................28Figure 22: Decomposition of productivity growth : within-sector vs. Structural adjustment............32Figure 23: Correlation between productivity and variation in employment per sector.....................33

1. The gains from trade

The tradional theory of international trade suggests that:

o Trade among countries generates efficiency gains for all countries, whatever their level of productivity.

o Countries specialize according to their comparative advantage, generating efficiencies.

1.1 Comparative advantage in Ricardo’s model

In the Ricardian model (not to be confused with the Ricardo-Viner model as we will see later, and which has nothing to do!), The assumptions are

2

Wine

Drape

40

20

PPF (Production Possibility Frontier)

Point of Consumption in Autarky

Indifference Curve

• Two countries (Portugal et GB)• Two sectors (wine and drape)• Only one factor of production (labor), perfectly mobile between the two sectors • Constant returns to scale• No transport costs• No government intervention• Perfect competition (price = cost)• At the same price, consumers share their budget equally between wine and drape

Thus, in the Ricardian model comparative advantage is determined by the relative productivity of labor, which is the only factor of production.

Table 1: Productivity and endowment data in a Ricardian example

Productivity Endowments (labor)

Wine DrapePortugal 8 4 5

UK 1 2 20

Figure 1: Production Possibility Frontier and autarky equilibrium : Portugal

Figure 2: Production Possibility Frontier and autarky equilibrium : Great Britain

3

Wine

Drape

20

40

PPF

Point of Consumption in Autarky

Indifference Curve

World Price Line

Wine

PPF

Drape

Indifference Curves

export

import

Equilibrium in the world market after openess of the two economies

Table 2: candidate equilibrium for the integrated world economy

Wine Drape Wine DrapePortugal 40 0 20 20

UK 0 40 20 20Total 40 40 40 40

Production Consumption

Figure 3: The gains from trade

Figure 4: The gains from specialisation

4

Indifference Curves

Wine

PPF

Drape

Lines of World prices

Point of Production

PPF initial

Steel

The impact of foreign investments

The impact of immigration

Textile

1.2 Comparative advantage with two factors: Heckscher-Ohlin

1.2.1 Concepts

Figure 5_ Factor Endowment and PPF: The Rybczynski Theorem

Figure 6: Factor Endowment and Comparative Advantage: The Heckscher-Ohlin Theorem

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“trade triangl

e”

Steel

Textile

Indifference curves

Relative Price on world market(tissu moins cher)

Point of consumption after structural adjustment

Autarky relative price

Point of production after structural adjustment

PPF

1.2.2 Measurement

When there are more goods than factors of production, in general the direction of trade (who exports what) is not determined.1 However, overall countries tend to export goods corresponding more or less to their factor endowments

Traditionally, we calculate the Balassa index of revealed comparative advantage : denote the

exports of product n by country i, the total exports of country i, world exports of product n, and world exports. The Balassa index then is:

The problem with this index is that it assumes the true theory: if the country i exports the good n, the index assumes that the country has a comparative advantage in this product; but the index does not use the factor endowment of country i. Using data on factor endowments from the UNCTAD, we can determine the « revealed » factor intensity of each product by taking the average

endowments of the countries that are exporting it. If is the endowment of capital of country i, the capital intensity of the good n is:

1 Can be found in trade flows with a continuum of goods as in Dornbusch Fisher Samuelson.

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where is a modified version of the Balassa index since .2 The advantage of this normalization is that it allows to put together national factor endowments and the products’ revealed intensities in the same formula. If the theory is true, the exports of countries should be relatively less scattered around their endowments.

Figure 7: Factor endowments and revealed factor intensities

Costa Rica 1993 Pakistan 2003-5

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Endowment point

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0 50000 100000 150000 200000Revealed Physical Capital Intensity Index

Error: Reference source not found (ctd) Tunisie 2003-5 Tunisie : new export products

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0 50000 100000 150000 200000Revealed Physical Capital Intensity Index

Moreover, the more the exported goods are far away from the factoral endowment of the countries, the less they survive on the world markets, despite the effect is quantitatively small :

Figure 8: Comparative advantage and the survival of exports

2 Caution: If some countries subsidize the exports of products that do not correspond to their comparative advantage, the computation is distorted (e.g. agricultural products to Europe). We must therefore correct for this bias in the computations.

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23

45

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2 2.2 2.4 2.6 2.8 3(mean) std_dist_1

(mean) length Fitted values

Length of trade relationship and distance to CA

1.2.3 Do countries specialize or diversify ?

On the other hand, the theory suggests that countries should specialize in their comparative advantage rather that to diversify. But specialization in raw materials, for example, can be synonymous of "imported volatility":

Figure 9: Fuel exports and GDP volatility

GABGABGABGABGABGABGABGAB

0.2

.4.6

.81

Coe

ffic

ient

of v

aria

tion

of G

DP,

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0-20

07

0 20 40 60 80 100Fuel share in exports

Recent studies also suggest that the decline in the volatility of GDP observed in recent decades in the United States is largely linked to the diversification of the economy (in services).

On the other hand, generally the concentration of exports follows a non-monotone path as countries develop : first diversification, then reconcentration. We measure the concentration of exports in

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similar way as we measure the concentration in income, by three indices: (i) Gini, (ii) Herfindahl, and (iii) Theil. Here we considered the index of Theil, whose formula is :

11\* MERGEFORMAT ()

Figure 10: Export concentration and the level of income 2

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8

0 20000 40000 60000 80000GDP per cap, 2005 PPP dollars

Theil index Theil index, UgandaFitted values

More concentrated than predicted

Less concentrated

than predicted

Uganda 2000 Predicted

Uganda 2010

And the reconcentration ocurred in the individual trajectories of countries :

Figure 11: Concentration: Individual country trajectories

IRL

ESP

GRC

GBR23

45

15000 20000 25000 30000 35000 40000GDP per capita, PPP (constant 2005 international $)

Which countries are those that re-concentrate?

Figure 12: The export re-concentration at high levels of income

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0020

0030

0040

0050

00nu

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prod

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0 20000 40000 60000GDP per capita PPP (constant 2005 international $)

Active lines - quadratic Active lines - non parametric

Theil index - non parametric Theil index - quadratic

# active export lines

Theil index

How can we explain the reconcentration? Essentially the inertia of trade flows, export lines that are closed have factor intensities corresponding to weaker endowments than those of countries that close. For example, the average of trade lines closed by the EU corresponds to the combined endowment of human and physical capital of Indonesia. These lines should be long gone, but they remain open by inertia.

Figure 13: What are the closing export lines?

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68

1012

0 50000 100000 150000 200000

Product intensities Country endowments

Capital

Human capital

In short, the theory seems to stick quite well with empirical observation, although the "content factors" does appear to explain only a small part of international trade. We therefore need other models to have a more complete view of its determinants.

On the other hand, so far everything discussed was essentially static: allocative efficiency considerations tell us nothing about the growth. In the models of endogenous growth, growth is mainly due to innovation ; international trade plays only an indirect role (i.e. through innovation).

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So we will discuss the relationship between trade and growth from an essentially empirical point of view, except a small detour to the Solow model in Section 3

1.3. Monopolistic competition and product variety

1.3.1 Homogenous firms

The monopolistic competition modelThe Heckscher-Ohlin model explains trade by differences in factor endowments. It cannot explain the trade between countries with similar endowments, and even less intra-industrial trade. We will now focus on an alternative model proposed by Krugman (1980), called « monopolistic competition».

The ingredients for a model of monopolistic competition are :

o Product differentiation that generates a finite elasticity for each firm o Economies of scale

The gains of trade in the MC model come from competition, which compresses margins and prices. Consider the following example from Krugman, Obstfeld and Mélitz (2012), pp 168-177

Let S be the volume of national trade, which we take as exogenously given (independant of the prices of the firms active in this market) which is of course unrealistic but simplifies the analysis greatly. Let n be the number of firms active in the market, b a parameter of demand (linear), Qi the quantity sold per company i, pi its price and the average price in the market.

Total cost is the sum of a fixed cost F and a marginal cost c :

which gives average cost of :

22\* MERGEFORMAT ()Demand function facing firm i :

33\* MERGEFORMAT ()

In a «symmetric  equilibrium» where all firms set the same price , it can be seen from (12)

that ; market shares are equal.

Optimal pricing by profit-maximizing firms equalizes marginal cost and marginal revenue. To derive marginal revenue, invert 3 to get the demand price:

44\* MERGEFORMAT ()Revenue is price multiplied by quantity

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55\* MERGEFORMAT ()and marginal revenue is the derivative of revenue w.r.t. quantity:

66\* MERGEFORMAT ()Marginal cost is simply c. Optimal pricing is therefore

77\* MERGEFORMAT ()Or

88\* MERGEFORMAT ()In the symmetric equilibrium where all firms adopt the same price, Q = S/n , optimal pricing simplifies to

99\* MERGEFORMAT ()In this equilibrium, average cost is found by substituting Q = S/n in (4), which yields

1010\* MERGEFORMAT ()With free entry, profits must be zero, which means that price has to equal average cost:

1111\* MERGEFORMAT ()or

1212\* MERGEFORMAT ()which determines the number of firms compatible with zero profits in the market (no incentive for additional entry). In this model, gains from trade arise because of

o Economic integration that creates a bigger marketo Increasing competition, reducing margins

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This can be seen by « merging » two countries with equal size S as part of a big-bang trade-liberalization experiment.

Effects of trade liberalizationWe do the comparison that is commonly done in international trade between an equilibrium in autarky and an equilibrium with free trade where all barriers are eliminated. The effect is illustrated in a numerical example in the excel file Exemple concurrence monopolistique.xlsx. Suppose that the two countries are of equal size and that there is no transportation cost. Then their combined size is , so the total number of firms is

and the equilibrium price and quantity are

So :

o The total number of varieties available to any consumer in the two-country area increases (there are fewer in each country but consumers have access to both)

o The equilibrium price is lower, and so are profit margins (not shown but easy to calculate)o Output per firm increases.

Damn it, everything is fine in this world?

1.3.2 Heterogeneous firms

Note that the trade liberalization induces firm exit, since . In a symmetric equilibrium, which firms will exit is indeterminate. But suppose now that potential entrants differ in their marginal cost ci, in accordance with new “heterogeneous-firm” models. Those with marginal cost higher than the « choke price » don’t enter.

Intercept of demand facing each firm: Using (13), Qi = 0 implies

And the slope of the demand curve is :

Trade liberalization means that goes down as n goes up, while the slope becomes “less negative” as S goes up. Thus, under the effect of an increase in S and the induced increase of n, the demand curve rotates anticlockwise.

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o The demand increases for big firms with low marginal cost o But it decreases for firms with higher marginal cost, which leads to the exit of some firms.

2. The openess-growth debate from the ’95 until today

2.1 Trade liberalization in a Solow model

Everything that we saw at the beginning of this chapter was static. Is there any reason to think that trade liberalisation could accelerate the growth? Yes if trade liberalization affects the price of capital goods, for example. To see this, we take the Solow model and assume that the domestic price of capital goods (the capital) is :

where is the world price of one unit of capital (one « machine ») and is the customs duty on

imported capital. Assume, to simplify, that , that is if we measure the capital in dollars, then one unit is worth a dollar . Rewrite the law of motion of capital as :

Then we have :

A high customs duty therefore lowers the curve in Figure 14; the steady state (the intersection of the curves, that are respectively representing the first term on the right of the equation above, and the second term) moves to the left (at a level of capital per worker lower) and the rate of growth during the transition to steady state, slows.

Figure 14: Effect of an increase in the custom duty rate on capital equipment in the Solow model

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In the particular case of capital goods, the link between trade liberalization is therefore direct (and obvious). This explains the 'climbing' structures of tariffs, prevailing in most developing countries : low or zero tariff on capital goods, moderate tariff rates on intermediate products used as inputs in the industry, and the highest rates on consumer goods.

2.2 The « East Asian Miracle »

Empirically, what can we say about the relationship between trade and growth?

The « East Asian miracle » is the title of a World Bank report published in 1994 and dedicated to the spectacular growth of the Asian tigers (compared to other continents, in aprticular Africa and Latin America). This report have had a great visibility despite very controversial.

Methodological part : « compatibility of growth » we assume a Cobb-Douglass production function :

13013\* MERGEFORMAT (.)

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Average TFP 1970-90 (% per year)

Taiwan

3.76Hong-

Kong3.64Kore

a3.10Japa

n3.48Thailan

d2.49Singapo

re1.19Malaysi

a1.07

Latin Am.

0.13Afr. sub-

sah.-0.99

where ui is the error term. Let ei be the residual of the estimation in Error: Reference source notfound.

14014\* MERGEFORMAT (.)

We will give a name to this residual : TFP (Total Factor Productivity). In growth rates then becomes :

15015\* MERGEFORMAT (.)

Is what we call TFPG (total factor productivity growth). The result is a decomposition of sources of growth in two components :

o Accumulationo Improved Efficiency (the residual)

This decomposition is very important. If accumulation (especially capital) is the dominant contribution to growth, the recipe for economic policy is the "mobilization of savings" for investment. This can be done - and has been historically - abruptly by taxing agriculture to generate the resources needed for investment. Extreme cases: the Soviet Union under Stalin. It is also what inspired many economic policies in Africa.

On the other hand, if the TFPG is dominant, then is something else. The problem is that as the TFPG is a residue, by definition it is not known what it is, and we could put what we want as interpretation.

Table 3: Estimated TFPG in the East Asian Miracle

There is clearly a difference in the nature of growth between the SE Asia and the remainder (AL and ASS). The TFPG is dominant in Asia, not elsewhere. Explanation: trade openness that forces local businesses to restructure and improve the efficiency.

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Unfortunately, the same year when the preliminary draft of the « East Asian Miracle » circulated, Alwyn Young published a paper that showed the labour factor was improperly measured (underestimated) for SEA (South East Asia) countries in the report of the Bank, the residual measured correctly was a bit smaller for these countries. Even more of a miracle!

Table 4: Estimation results of Young (1993)

Source : Young, 1993

2.3 The cross-sectional evidence

2.3.1 Trade openess index of Sachs-Warner

Idea: correlate the growth in the period 1980-90 with a measure of trade openess. Bianary measure : either open or closed country. « Closed » if one of more of the following criteria are satisifed:

1. Average tariff greater than 40%2. Rate of coverage of non-tariff barriers (quotas etc.) greater than 40% of imports3. Black market currency premium greater than 20% during the decade 4. Export State Monopoly5. Socialist Economy

SW found a strong correlation between growth and their measurement of the opening. Already in descriptive statistics, the difference is clear :

Figure 15: Average growthe for closed and open economies

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Source : Sachs Warner (1995)

In addition there is convergence among the open countries but not closed countries:

Figure 16: convergence among closed economies

Source : Sachs Warner (1995)

Figure 17: Convergence among open economies

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Source : Sachs Warner (1995)

The cross-section regression results confirm the descriptive statistics (table 5).

Table 5: Growth and openness: Cross-section regression results 1980-90

Source : Sachs Warner (1995)

Edwards (1998) attempted to show that the results of Sachs and Warner were robust and not the effect of a particular approach. It includes all of the openess measures (Sachs and Warner and other) and systematically explores the correlation between these measures and the TFPG.

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OPEN Sachs-Warner

WDR Openess Index of the World Bank (composite)

LEAMER Residual of an equation of openess

BLACK Balck market premium on currrencies

TARIFF Average import tariff

QR Rate of coverage of quantitative trade barriers

HERITAGE Trade-distortion perception index

CTR Revenue on import taxes in proportion of the value of imports

WOLFF Another residual of a regression of openess

SW results are robust; several other similar exercises give the same results

Table 6: TFP growth regressions with various openness indices

Source : Edwards 1998.

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Basically, the message is that regardless of the measure of openess that we take, the correlation with the TFPG seems well-established. The message of the East Asian Miracle was fundamentally correct even if the measures are differentgood this is.

2.3.2 The critique of Rodriguez et Rodrik

Rodriguez et Rodrick (2001) show the opposite. They do an exercise of brutal deconstruction of all this econometrics, in particular of the econometrics of Sachs Warner.

Table 7: Regression results of Rodrik Rodriguez with the decomposed SW index

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Figure 18: Growth and import tariffs

Source : Rodriguez et Rodrik (2001)

Figure 19: Growth and NTB coverage ratios

Source : Rodriguez et Rodrik (2001)

So what explains the differences of TFPG, is not so much trade policy stricto sensu, but rather macroeconomic policy (the overvaluation of the exchange rate measured by the premium on currencies) and export monopolies. But what country had exchange rates overvalued in the 1980s? But that had exchange rates overvalued in the 1980s? Latin America. Which country had export monopolies? Africa.

2.4 The evidence in panel

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All first generation studies were cross-sectional. Wacziarg and Welsh (2008) remake the estimates in panel data by carefully identifying the date of trade liberalization (while SW did not date, since they were using a cross-sectional over a decade). Employing a panel allows to use the fixed-effects estimator (dummy variables that capture country-invariant characteristics over time). The effect is much better identified, as it is "within-country" that is to say, it filters the heterogeneity between countries due to unrelated trade openness factors.

Table 8: Trade liberalization dates in Wacziarg and Welsh

Table 9: Details of trade reforms by country

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Results : Reproducing exactly the exercise of SW, they find the same findings :

Table 10: SW results reproduced

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Contrariwise, when running the same regressions on another time period (the 90s) , nothing stays significant :

Table 11: SW results on a different time period

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What to make of it? The answer comes with panel regressions where the fundamental explanatory variable is the date of trade liberalization; the date of the liberalization contains additional information that is not distorted by other unexplained differences between countries entre pays (since we use the difference in time for each country).

Table 12: Growth and openness in panel

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Once doing this, the results become correct for all periods – far more convincing. Figure 20 displays the results in a more intuitive way. Time is normalized to be zero in the year of trade liberalization for each country (so if Colombia liberalises in 1995, 1994 = -1, 1995 = 0, 1996 = 1 for Columbia ; if Chile liberalises in 1970, 1969 = -1 etc.). Each point on the curve is the average of the sample growth at t = -10, t = -9, etc. We observe an accelaration of growth of about 1.5 percentage points around the year zero.

Figure 20: Time profile of growth around liberalization year

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Figure 21 shows the same finding for investment. We observe a spectacular rise in the rate of investment after the liberalization.

Figure 21: Time profile of investment around the liberalization year

On the other hand, the identification problem remains still unsolved in Wacziarg and Welsh due to the fact that the trade reforms were often implemented at the same time as reform packages that affected several other sectors of the economy (macroeconomic stabilizations, privatizations, governance reforms, etc.) and oftentimes also coincide with changes in government. So : is it really the trade liberalization causing the effects or other simultaneous developments?

Estevadeordal et Taylor (2009) revisited the question in the different ways where the second one is interesting in itself to understand for the used methodology.

Approach 1 (« simple differences »)

The regress the change in growth on the change in tariffs in a panel of countries—a standard

technique. With i representing a country, t the time, the growth of country i at time t,

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a country-specific vector (human capital and characteristics of governance), and the average of tariffs of country i in time t.

1616\* MERGEFORMAT ()And the same for other variables put in differences. The equation becomes

1717\* MERGEFORMAT ()Approach 2 (« differences in differences »)

E&T use as natural experiment the liberalization implemented by a number of countries during trade negotioations in Uruguay (the « Uruguay Round » that took place between 1986 and 1994). Certain countries liberalized their tariffs; they form the « treatment group » ; other countries that didn’t liberalize are put in the « control group ». Again, the sample structure is a panel, but now the estimation technique is called « differences in differences ». This term expresses that we compare the performance before and after a certain date where the treatment starts (the first difference), but for two groups, the treatment and the control group (second difference). This estimation technique is commonly used in medical sciences.

With being a dummy variable marking belonging to the treatment group and the treatment period (after the Uruguay round) ; so

The basic equation becomes

1818\* MERGEFORMAT ()

And the coefficient gives the treatment effect. We can also re-write 18 in a simpler way with fixed effects for countries and years:

1919\* MERGEFORMAT ()Finally a third way of writing and estimating this equation consists of defining two long periods (

and ), which gives us a two-period panel, and taking the change between those two periods :

2020\* MERGEFORMAT ()Which yields

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2121\* MERGEFORMAT ()

The basic results of the Diff-in-Diff approach (DD) are displayed in Error: Reference source notfound. The first column uses the average of tariffs for all goods as regressor of interest (« liberalizer indicator »); the second column uses the average of tariffs only on consumption goods, the third uses the average on tariffs on equipment goods and the fourth uses the average tariff on intermediate goods. We find that the coefficients are significant and estimated more precisely for the equipment goods than for consumption goods. However, the effects are rather weak.

Table 13: Growth regressed in the liberalization indicator

The results of the first approach are very similar, but with the opposite sign since lower tariffs accelerate growth :

Table 14: Growth regressed on tariff changes

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Again, the coefficients are very small (signalizing a very weak effect) and only significant at the 10% level (signalizing that the effect is not well measured). Contrariwise, the coefficient on the tariffs for equipment good sis two times higher than the coefficient for consumption goods, which is in line with the basic growth model of section 2.1.

EndogeneityThe two approaches face similar problems, firstly endogeneity and secondly selection. They only handle the first problem, where the problem is that the variation in tariffs and the variation in growth could be explained by the same omitted variable, for example a change in government.3

The instrumental variable is the interaction between two things:

1. The intensitiy of the Great Depression in the observed countries2. The level of tariffs in the countries before the Uruguay round.

The idea of the first element is that suffered more in the Depression have more than others lost the faith in liberalism and adopted more protectionist policies afterwards, which could have survived until today and resulted in less willingness for a liberalization. The idea of the second element is that for liberalzing, countries must have entered the Uruguay round with high tariffs (otherwise no need for liberalization) So low intensity of the Great Depression × high level of tariffs predict a strong liberalization in the Uruguay round.

Table 15: Approach 1 with instrumental variable

3 In the seond approach, we face a selection problem. The approach relies on the hypothesis that the decision to take the treatment is uncorrelated with the potential effect of the treatment. In fact, if the countries that liberalized were systematically more likely to benefit from the treatment, we cannot use the equation (7) to deduct that the same effect would have worked in the countries that were not treated. Therefore we have to control for this selection effect that is always present when the treatment is not given at random, but this control is not done here.

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We note that the effect is now stronger and more significant (it’s the « second stage » that we care about; we have -0.05 now vs. -0.03 before, and the effect is significant at 5%).

3. Structural adjustment and resource allocation

Is this the end of the debate ? Not yet. In a recent paper, McMillan et Rodrik (2010) have decomposed the growth of productivity and shown a result opposing the message of the beginning of the course :

o The productivity growth in a sector is comparable across countries ; particularly there is no substantial difference between Africa and America as before

o In contrast, in favour of a structural adjustment : in these two regions ressources have moved from sectors with high productivity growth towards sectors with low productivity growth.

Supposing that the productivity of the manufacturing sector was a weighted average of the productivity of several sectors.

with . We can express its variation, as

Representing the first term in grey and the second in black in averages per region, McMillan and Rodrik (2011) obtain in Figure 22:

Figure 22: Decomposition of productivity growth : within-sector vs. Structural adjustment

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Source : McMillan and Rodrik (2011).

The grey component doesn’t really vary from one region to the other. However, the black part really makes a difference. The structural adjustment has moved resources to the wrong place! The case of Argentina is particularly interesting  (Figure 23).

Figure 23: Correlation between productivity and variation in employment per sector

Source : McMillan and Rodrik (2011).

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References

Edwards, Sebastian (1998); “Openness, Productivity and Growth: What Do We Really Know?”; Economic Journal 108, 383-98.

Estevadeordal, Antoni, and Alan Taylor (2009), “Is the Washington Consensus Dead? Growth, Openness, and the Great Liberalization, 1970s-2000s”; IDB working paper IDB-WP-I38; Washington, DC: Inter-American Development Bank.

McMillan, Margaret S. and Dani Rodrik, “Globalization, Structural Change and Productivity Growth,” Working Paper No. 17143, NBER (http://www.nber.org/papers/w17143), June 2011.

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