Does Trade Reform Promote Economic Growth? A Review of Recent Evidence



Douglas A. Irwin | Peterson Institute for International Economics

Economists will look back on the decade from 1985 to 1995 as a remarkable period in which developing coun- tries were swept up in a dramatic wave of trade reform that led to much greater openness in the world economy. Did the reduction in import restrictions and other trade barriers pay off in terms of faster growth, greater invest- ment, or higher productivity for the countries that chose this path?

An early set of papers, including Dollar (1992), Sachs and Warner (1995), and Edwards (1998), found support for the idea that openness to trade was associated with better economic outcomes. But these papers were subjected to a wide-ranging critique by Rodríguez and Rodrik (2000, 266), who concluded that “the relation- ship between trade policy and economic growth remains very much an open question” and “is far from having been settled on empirical grounds.”

Twenty years have elapsed since Rodríguez and Rodrik last surveyed the field and there are several reasons why this question deserves reexamination. First, many of the early papers had sample periods that ended in the early 1990s, around the time when many big reforms were just being implemented. Any assessment of the impact of these reforms would have been premature at that point, given the length of time it takes to determine if changes in policy have been rewarded with an economic payoff. More recent studies have additional data with which to evaluate the trade reforms undertaken in the late 1980s and early 1990s.

Second, more countries have undertaken trade reforms, giving us a larger sample of country experiences than were considered in the earlier literature. For example, at the time of Sachs and Warner (1995), China and India were considered “closed” economies, as were Vietnam, Cambodia, and Bangladesh. Such countries provide additional evidence on the economic consequences of a more open trade regime.

Third, recent work has employed new and varied empirical methods that address many of the concerns raised about earlier studies. Studies have moved away from cross-sectional (between-country) comparisons to looking at within-country growth following a reform episode. These studies have been supplemented with synthetic control methods that allow for a more structured “counterfactual” scenario against which to judge the outcome of reforms. In addition, empirical studies and model-based simulations of particular countries have focused on the channels through which reductions in trade barriers might improve economic performance. These papers often use cross-industry variation in the reduction of trade barriers to identify the impact of increased imports on domestic producers, with a focus on how the reduction in cost and increase in variety of intermediate goods improves the productivity of final goods producers.

This paper reviews recent work on trade reform and economic growth as a way of understanding what progress has been made in uncovering the link between the two. A consistent finding is that trade reforms that significantly reduce import tariffs have a positive impact on economic growth, on average, but as one would expect the effects differ considerably across countries. These results are fairly uniform across methods of analysis, different indicators of trade policy, and other dimensions. The microeconomic evidence that lower tariffs on intermediate goods lead to improved productivity performance of domestic final goods producers is even stronger. Overall, these research findings suggest that the outcome of trade reforms can be seen in a more positive light than the agnosticism left in the wake of the Rodríguez and Rodrik critique.

This positive assessment is consistent with recent findings in two different but somewhat related areas of research. First, until recently the consensus among economists was that poorer countries were not growing faster and therefore not catching up to richer countries, although there was evidence in favor of “convergence clubs.” Patel, Sandefur, and Subramanian (2018) find strong evidence of unconditional income convergence across countries starting around 1990 but especially since 1995.
Second, research during the 1980s and early 1990s failed to find a significant relationship between policy reform and economic outcomes. The subtitle of Easterly (2001) was “developing countries’ stagnation in spite of policy reform.” He concluded in Easterly (2005, 1017): “Although extremely bad policy can probably destroy any chance of growth, it does not follow that good macroeconomic or trade policy alone can create the condi- tions for high steady state growth.”
In updating these previous studies, Easterly (2018) now finds that policy and economic outcomes have improved considerably since the 1990s and are positively correlated. As he puts it: “If the old stylized facts on disappointing growth accompanying reforms led to widespread doubts about the value of economic reforms, the new stylized facts should lead to some more positive updating of such beliefs.”

This paper begins by documenting the wave of trade reform that swept the world in the late 1980s and early 1990s. It then looks at the different methods used to assess the links between trade reform and economic perfor- mance, including cross-country regressions, synthetic control, and empirical or quantitative country studies, discussing the virtues and vices of each approach.
The paper focuses on the impact of trade reforms, meaning unilateral reductions in trade barriers; it does not discuss research on several related issues, including the relationship between trade and the level of national income, a question examined by Frankel and Romer (1999), Noguer and Siscart (2005), Feyrer (forthcoming), and others. The general finding of this research is that an exogenous increase in trade has a positive, and poten- tially large, impact on national income. However, a policy decision to change trade barriers that leads to an increase in trade may not have the same impact on income as an exogenous increase in trade driven by other factors, such as declining trade costs. This paper does not examine the cross-sectional relationship between the level of trade barriers and economic growth. The focus is on how changes in a country’s own trade barriers (trade liberalization episodes) affect its own economic growth.

This paper does not examine the domestic distributional impact of trade reform, such as the implications for inequality (surveyed by Pavcnik 2017), labor market adjustment (surveyed by McLaren 2017), or the incidence of poverty (surveyed by Winters and Martuscelli 2014). The paper does not look at the impact of a reduction in trade barriers that come about from free trade agreements (Baier, Yoto, and Zylkin 2019) or regional free trade areas, such as the European Union (Campos, Coricelli, and Moretti 2019).

The evidence in recent studies comes mainly from developing countries and emerging markets rather than from advanced countries. Developing countries have had much higher barriers to trade than advanced countries and have much greater opportunities for catch-up growth, because they are farther behind the technological frontier. While many OECD countries have undertaken trade reforms, sometimes significant ones, over the past few decades, developing countries are where the largest potential payoffs to increased participation in world trade are likely to have been.

Does Trade Reform Promote Economic Growth?

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