1.0 Introduction
Many developing countries have embarked on programs of trade and financial liberalization. The effect of the trend towards trade policy openness on per capita income growth is one of the most controversial issues as there is a tendency to improve imports more than exports leading to trade deficits and consequently contributing to low economic growth in future. Many analysts believed that trade policy openness and higher ratios of trade volumes were positively correlated with economic growth until Rodriguez and Rodrik (2000) raised some concerns about the robustness of these results as conclusions remained sensitive to difficulties in measuring openness, statistically sensitive specifications and co-linearity of protectionist policies with other poorly executed policies in developing economies. Wacziarg (2001) attempted the measurement of liberalization variable as Sachs and Warner classification posed problems on their categorization of open and closed economies. Like Wacziarg, we intend to use the updated data on income levels (Summers, Heston and Aten, 2001) which provides us
with the basic information to examine the relationship between trade openness and economic growth before and after liberalization and study the relationship between investment, liberalization and time period elapsed from liberalization. Both aggregate region level and country level study for selected countries are attempted. Data period of our interest ranges from 1970 to 2000 and the relationship between trade balance and economic growth may have undergone changes from one decade to the next in many regions of the world. We intend to analyze whether region level growth and trade balance are affected by liberalization. Timing of liberalization within a country could also affect the relationship.
There has been a long-held belief that there is an association between economic growth and increased trade. Subsequently the benefits of an economy becoming ‘open’ have been promoted in both academic and policy making circles (see for example Krueger, 1997). However, the views over how to measure openness and the degree to which a country alters its degree of openness (via liberalization of trade policies) are less concordant. In addition, recent skepticism has arisen over the validity, or at least the generality, of the hypothesis that links openness to growth.
Focusing first on the hypothesis itself, evidence has been raised at the empirical and theoretical level that questions whether the relationship between openness and growth is necessarily always positive. At the very least, the debate is not settled. Theoretical models predicting a positive association (River-Batiz and Romer, 1991; Grossman and Helpman,1991 and Devereux and Lapham, 1994) can be contrasted with those yielding the opposite (Redding, 2002). Similar contradictions exist empirically. While many papers such as Edwards (1998), Wacziarg (2001) and Greenaway et al (2002) estimate a positive relationship, others find the opposite even when using similar measures of openness (Rodrik and Rodriguez, 2000; Clemens and Williamson, 2002; Vamvakidis, 2002).
The sensitivity of the growth outcomes from greater openness has led some to suggest that effects are conditional on some other factor omitted from the regression model. For trade liberalization a large set of variables have been put forward to explain the proposed heterogeneity, including education, existing levels of development, the strength of domestic institutions, macroeconomic stability and measures to tackle corruption (Winters, 2004).
