Download Does Trade Cause Growth? By JEFFREY A. FRANKEL AND DAVID

Does Trade Cause
Growth?
JEFFREY A. FRANKEL AND DAVID ROMER
by ILKER KAYA
*
The big question
 What
is the impact of
international trade on
standards of living?
Technical Challenge
 How
are we going to measure
the effect of international trade
on income (standards of living)
Problems


The trade share may be endogenous:
countries whose incomes are high for
reasons other than trade may trade more.
There is not enough available data
Why this estimation is
different?

In contrast to conventional gravity
equations for bilateral trade, this trade
equation includes only geographic
characteristics: countries’ sizes, their
distances from one another, whether they
share a border, and whether they are
landlocked.
Main assumption
A
country’s geographic
characteristics have
important effects on its
income through their
impact on trade
We can use geographic
characteristic as IV because;


Countries’ geographic characteristics are
not affected by their incomes, or by
government policies and other factors that
influence income.
The instrument depends only on countries’
geographic characteristics, not on their
incomes or actual trading patterns.

average income in country i is a function of
“international trade” and “within-country trade”,
and other factors:
(1) ln Yi = α + βTi + γWi + Єi.
Yi = income per person,
Ti = international trade,
Wi= within-country trade,
Єi = other influences on income.
international trade
(2) Ti =Ψ + ΦPi + δi
Pi=proximity to other countries,
δi= other factors
within-country trade
(3) Wi = η + λSi + νi
Si = the country’s size,
vi= residuals (other factors)


The residuals in these three equations, Єi,
δi and vi, are likely to be correlated.
The key identifying assumption of this
analysis is that countries’ geographic
characteristics (their P ’s and S ’s) are
uncorrelated with the residuals(Є ) in
equation (1) and correlated with T and W
The main equation estimated;
N = population
A = area
L = dummy for landlocked countries
B = dummy for a common border
between two countries.
Results of main estimation

Distance has a large and overwhelmingly significant
negative impact on bilateral trade.

Trade between country i and country j is strongly
increasing in j’s size.

If one of the countries is landlocked, trade falls by about
a third.

Sharing a border has a considerable effect on trade.

The regression confirms that geographic variables are
major determinants of bilateral trade.
Aggregate Trade

ln(‫ד‬ij/GDPi) = a’Xij + eij,

Tˆi = ∑j≠i e aˆ’Xij


estimation of the geographic component of country i ’s
trade is the sum of the estimated geographic
components of its bilateral trade with each other country
in the world.
for all countries, not just those for which we have
bilateral trade data
Estimates of Trade’s Effect on
Income

ln Yi = a + bTi + c1ln N i +c2ln Ai + ui
Yi = income per person in country i
Ti = trade share
N i = population
Ai = area
Basic results


The regression shows a statistically and
economically significant relationship
between trade and income.
Controlling for international trade, there is
a positive relation between country size
and income per person.
Basic results continued

The coefficient on area is positive. The
reason is sampling error or greater area
has a negative impact via decreased
within-country trade, but a larger positive
impact via increased natural resources.

Using population alone to measure size
has no major impact on the results.
Why Are the IV Estimates
Greater Than
the OLS Estimates?


1.
2.
The IV estimate is almost always
considerably larger than the OLS
estimate
There are two leading explanations
It is due to sampling variation.
OLS is in fact biased down.
Conclusions


There is no evidence that the positive
association between international trade and
income arises because countries whose incomes
are high for other reasons engage in more trade.
The point estimates suggest that the impact of
trade is substantial. The ratio of trade to GDP by
one percentage point raises income per person
by between one-half and two percent.
Conclusions


Increased size raises income. This
supports the hypothesis that greater
within-country trade raises income.
The impacts of trade and size are not
estimated very precisely. As a result, the
estimates still leave considerable
uncertainty about the magnitudes of their
effects.
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Trade
GDP
Size
Population
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THE END
PowerPoint is
And I learned how to
use it……