The Link between Trade and Income: Export Effect, Import Effect, or Both?

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The Link between Trade and Income: Export Effect, Import Effect, or Both?

Shuo Zhang

Jan Ondrich

J. David Richardson1

Department of Economics

Syracuse University

March 2003

A new framework is developed to evaluate how cross-country differences in export openness and import openness in 1990 affected the level of real per capita income. Familiar and novel instruments are used to extract the exogenous components of total trade (exports plus imports) and of net exports (exports minus imports), which in turn imply distinct export and import effects. We build on an existing literature (Frankel-Romer and others) that uses aspects of a country’s geography as instrumental variables for total trade openness. We build on a country’s demography and net wealth abroad to develop a novel instrument for net export openness. Our new estimates reveal that export openness alone correlates with income cross-sectionally, not import openness.

I. Introduction

The doctrine of mercantilism views trade, at least in part, as a zero-sum game. Trade is considered favorable if exports bring in more money than what is paid out for imports. Adam Smith and David Ricardo challenged the mercantilism theory by arguing that overall openness is what matters – nations grow more prosperous through the process of specialization and trade through imports as well as exports. Many developing countries have replaced their strategy of government-protected import substitution industrialization with a market-focused export oriented strategy. They seek to promote economic growth by exporting more and more of their products; this has the feel of neo-mercantilism.

This paper re-poses the question whether trade “raises” a country’s income per person (or per worker); and if it does, what are the channels through which trade affects income, exports or imports? Numerous theoretical and empirical studies have attempted to answer these questions. Theoretical support for the positive link between different sorts of openness and economic growth were provided by Romer (1986) and Lucas (1988). Barro and Sala-i-Martin (1995) and Romer (1992) emphasized how countries that are more open have a greater ability to absorb (import) technological advances, which ultimately leads to higher real per capita income. Krugman (1974), Rodrik (1995), and Rodriguez and Rodrik (2000) on the other hand, cast doubt on the impact of openness on growth. Warner (2003) casts doubt on their doubts and views our central question as a frontier issue.2

Empirical studies construct measures of openness variable based on exports3, imports4, or the sum of the exports and imports5. Levine and Renelt (1992) argue that “all findings using the share of exports in GDP could be obtained almost identically using the total trade or import share. Thus, studies that use export indicators should not be interpreted as studying the relationship between growth and exports per se but rather as studying the relationship between growth and trade defined more broadly.” (p.959) Grossman and Helpman (1991) stated that technological spillovers could come via imports as easily as exports. Lawrence and Weinstein (2001) argue that imports, not exports, contribute importantly to the productivity growth of Japan and Korea.

Frankel and Romer (1999), on which chapter one of this dissertation is based (Zhang 2002a), alleviates many of the conceptual and econometric barriers to these issues by showing how geographical characteristics provide an arguably good instrument for a country’s intrinsic openness. Yet they remark that their trade and income investigation cannot separate the import effect and export effect. Wei (with Wu 2001, 2002a, 2002b) consciously follows Frankel’s and Romer’s lead in a study of how globalization affects Chinese city-level growth and inequality. Wei conflates export and import influences by selecting Chinese cities’ distanced to two major Chinese ports as his instrument for a city’s natural openness.

No one to our knowledge has yet figured a way to do what seems initially the most natural thing. That is to construct a measure of export openness, then an arguably independent measure of import openness, and investigate whether one has a different effect on income than the other, ceteris paribus.

That is the principal objective of this paper -- to identify the separate influences of export openness and import openness on income levels after controlling for endogeneity. In particular, we develop a framework that is slightly different from the Frankel and Romer (1999) income determination model by considering an additional “net trade effect” on income levels. When combined with Frankel and Romer’s “total-trade” effect, the two effects together imply separable export and import effects. The extended income model is intended to contribute to three empirical challenges related to trade and income. The first is the Frankel-Romer determination of instruments for total trade. The second is the determination of instruments for net trade. Thirdly, the model and data employed permit the identification of the impact of exports and imports on income separately.

Our concern about endogeneity in this chapter differs slightly from our concern in the previous chapter. When considering exports and imports separately, the expected bias from ignoring endogeneity is, respectively, caused by the unobserved income determinants that are correlated with exports and imports.

This paper (Zhang 2002b) is one part of my three dissertation papers (Zhang 2002a, Zhang 2002b, Zhang 2003). Zhang (2002a) explores the sensitivity of the Frankel and Romer (1999) empirical relationship between country’s total-trade openness and income level to heteroscedasticity and sample selection in their first-stage bilateral instrumenting regressions. The results support their hypothesis that trade has a significant and positive, yet relatively small impact on income. The present chapter tries to differentiate Frankel’s and Romer’s export openness from import openness. Export openness plays the dominant role. Unfortunately, the unique instrumenting techniques for “net trade” in this chapter cannot be implemented bilaterally, so there remains some doubt about the exact onformity of our conclusions to Frankel and Romer’s. Zhang (2003) employs established and new panel econometrics techniques to further examine the robustness of the findings presented in Frankel and Romer (1999), Zhang (2002a), Zhang (2002b) and other literature.

The rest of the paper is as follows. Section II describes the models. Section III provides data definitions and sources. Section IV reports the empirical results and Section VI contains the conclusions of the paper.

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