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Without trade openness, there is no sustained growth

Arvind Panagariya

Recent attacks on globalisation have also translated into attacks on the wisdom of outward-oriented trade policies that developing countries have embraced with increasing frequency. Free trade sceptics question the ability of liberal trade policies to stimulate growth. As a corollary, they also blame growth failures on the surge of imports resulting from increased openness. Furthermore, they view outward-oriented trade policies as detrimental to the fate of the poor.

Are the sceptics right? The answer is a categorical no. In so far as developing countries are concerned, there is compelling evidence that openness is a necessary condition for rapid growth. There are few developing countries that have grown rapidly on a sustained basis during the post-Second World War era without simultaneously experiencing rapid growth in their exports and imports. Because openness by itself is not sufficient to promote growth — macroeconomic stability, policy credibility and perhaps other policies must usually accompany it — one can surely find examples of countries opening up without experiencing growth. But this is quite different from saying that openness is either inessential or detrimental to growth when it does happen.

In the same vein, countries that have achieved significant poverty reduction are generally those that have grown rapidly and have, in turn, been open to trade. The most obvious examples are the Newly Industrialised Economies (NIEs) including Hong Kong, Singapore, Republic of Korea and Taiwan that have entirely eliminated poverty according to the dollar-a-day poverty line. On the other hand, countries such as India that remained autarkic and grew at less than 1.5% in per-capita terms until late seventies experienced little reduction in the trend poverty ratio. Both India and China achieved significant poverty reduction only after they began to dismantle autarkic policies and began to grow rapidly.

In my own recent research, I have analysed the data for a large number of countries for 38 years spanning over 1961 to 1999, made available by the Global Development Network.* I divide these data into two 19-year periods and identify, for each period, what I call growth “miracles” and “debacles”. The former are defined as countries that grow at 3% or more in per-capita terms and the latter those experiencing a decline in the per-capita income. I find that miracle countries invariably experience a very rapid expansion of exports and imports while debacle countries rarely do.

Thus, consider the period 1961-80. These years are commonly identified with import-substitution. Yet, the remarkable fact is that virtually all miracle countries during this period rapidly expanded their exports and imports. The countries in this group came from virtually all continents including Latin America, which is often described as having led the developing world in the area of import substitution. Brazil, which grew at 4.6% during 1961-80, expanded its exports and imports at 8.1 and 7.6%, respectively, over the period. Among countries that grew at 3.6% or more, the lowest recorded growth rate of imports was 7.2% for Tunisia, which grew at 4% in per-capita terms. Even as we go down the list, there are only two countries that registered relatively low growth rates of imports: Mauritius and Kenya with import growth of 3.8 and 3.6%, respectively.

If we look at growth debacles, the weight of evidence is hugely against trade being the culprit . Out of the seven debacle cases on which we have data on trade, only two show significant growth in imports. In the other cases, declines in per-capita terms are accompanied by import growth of less than 2%.

This pattern is repeated during 1981-99. The key difference is that the number of miracle countries in the latter period is smaller and that of debacle countries larger. But remarkably, the total population enjoying miracle growth rates at the beginning of the first period at 356.5 million was considerably smaller than that at the beginning of the second period at 2.1 billion. The popular belief that 1980s and 1990s were lost decades of development while 1960s represented the golden period of growth is too simplistic. While it is true that the population experiencing a decline in per-capita incomes during 1980-99 was vastly larger than in 1961-80 — partially due to the implosion of the Soviet Union and East and Central European countries — the developing country population experiencing rising living standards during 1980-99 was also much larger on account of China and India growing at 8.3 and 3.8%, respectively.

Critics often capitalise on the observation that openness by itself does not always lead to the resumption of growth to ask rhetorically: Why should a country take the painful decision to liberalise if it is not going to immediately result in increased incomes? But this misses the point. Our ability to predict when and what will trigger the process of growth in a country is limited. What we do know, however, is that openness is almost always essential for it. Therefore, it makes sense to be ready with an open trade regime should the opportunity knock at the door.

The point is duly illustrated by the contrasting post-war experiences of Korea and India until late 1970s. Increased savings rates offered both countries growth opportunities but only Korea was able to take advantage of it. With its emphasis on producing everything domestically including machinery and raw materials, India choked off the growth potential it had created for itself.

Critics may still persist that even if fast growth in trade volumes accompanies fast growth in incomes, how can we be sure that lower trade barriers accompany the latter as well. Admittedly, evidence on the direct relationship between trade barriers and income growth has been more controversial but if one must choose a policy variable to allow trade to grow faster, the reduction in trade barriers is likely to be the prime candidate.

April 23, 2003