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```Does Trade Cause
Growth?
JEFFREY A. FRANKEL AND DAVID ROMER
by ILKER KAYA
*
The big question
 What
is the impact of
standards of living?
Technical Challenge
 How
are we going to measure
on income (standards of living)
Problems


The trade share may be endogenous:
countries whose incomes are high for
There is not enough available data
Why this estimation is
different?

In contrast to conventional gravity
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
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

average income in country i is a function of
and other factors:
(1) ln Yi = α + βTi + γWi + Єi.
Yi = income per person,
Єi = other influences on income.
(2) Ti =Ψ + ΦPi + δi
Pi=proximity to other countries,
δi= other factors
(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

Trade between country i and country j is strongly
increasing in j’s size.

a third.

Sharing a border has a considerable effect on trade.

The regression confirms that geographic variables are

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
Income

ln Yi = a + bTi + c1ln N i +c2ln Ai + ui
Yi = income per person in country i
N i = population
Ai = area
Basic results


The regression shows a statistically and
economically significant relationship
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
It is due to sampling variation.
OLS is in fact biased down.
Conclusions


There is no evidence that the positive
income arises because countries whose incomes
are high for other reasons engage in more trade.
The point estimates suggest that the impact of
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
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.
500
450
400
350
300
250
200
150
100
50
0
GDP
Size
Population
1st Qtr 2nd
Qtr
3rd
Qtr
4th
Qtr
THE END
PowerPoint is
And I learned how to
use it……
```
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