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Does trade cause growth?

Our World in Data presents the empirical evidence on global development in entries dedicated to specific topics. In this blog post we cover the link between globalization and economic growth. In two separate companion posts we cover the link between globalization and jobs, and the link between globalization and inequality. These articles draw on data and research discussed in our entry on International Trade.

  • At the cross-country level, there is a correlation between economic growth and rising international trade.
  • Some of the most cited papers in this field (e.g. Frankel & Romer 1999 and Alcalá & Ciccone 2004) rely on long-run macroeconomic data and find evidence of a causal relationship: trade is one of the factors driving economic growth.1
  • Other important papers in this field have focused on microeconomic evidence, exploring the causal impact of specific trade liberalization policies on firm-level productivity within countries. These studies also find that trade liberalization has led to growth in the productivity of firms.2

The raw correlation between trade and growth

Over the last couple of centuries the world economy has experienced sustained positive economic growth, and over the same period, this process of economic growth has been accompanied by even faster growth in global trade.

In a similar way, if we look at country-level data from the last half century we find that there is also a correlation between economic growth and trade: countries with higher rates of GDP growth also tend to have higher rates of growth in trade as a share of output. This basic correlation is shown in the chart below, where I plot average annual change in real GDP per capita, against growth in trade (average annual change in value of exports as a share of GDP).3

Is this statistical association between economic output and trade causal?

Among the potential growth-enhancing factors that may come from greater global economic integration are: Competition (firms that fail to adopt new technologies and cut costs are more likely to fail and to be replaced by more dynamic firms); Economies of scale (firms that can export to the world face larger demand, and under the right conditions, they can operate at larger scales where the price per unit of product is lower); Learning and innovation (firms that trade gain more experience and exposure to develop and adopt technologies and industry standards from foreign competitors).4

Are these mechanisms supported by the data? Let's take a look at the available empirical evidence.

Click to open interactive version

Causality: Evidence from cross-country differences in trade, growth and productivity

When it comes to academic studies estimating the impact of trade on GDP growth, the most cited paper is Frankel and Romer (1999).5

In this study, Frankel and Romer used geography as a proxy for trade, in order to estimate the impact of trade on growth. This is a classic example of the so-called instrumental variable approach. The idea is that a country's geography is fixed, and mainly affects national income through trade. So if we observe that a country's distance from other countries is a powerful predictor of economic growth (after accounting for other characteristics), then the conclusion is drawn that it must be because trade has an effect on economic growth. Following this logic, Frankel and Romer find evidence of a strong impact of trade on economic growth.

Other papers have applied the same approach to richer cross-country data, and they have found similar results. A key example is Alcalá and Ciccone (2004).6

This body of evidence suggests trade is indeed one of the factors driving national average incomes (GDP per capita) and macroeconomic productivity (GDP per worker) over the long run.7

Causality: Evidence from changes in labor productivity at the firm level

If trade is causally linked to economic growth, we would expect that trade liberalization episodes also lead to firms becoming more productive in the medium, and even short run. There is evidence suggesting this is often the case.

 Pavcnik (2002)8 examined the effects of liberalized trade on plant productivity in the case of Chile, during the late 1970s and early 1980s. She found a positive impact on firm productivity in the import-competing sector. And she also found evidence of aggregate productivity improvements from the reshuffling of resources and output from less to more efficient producers.

Bloom, Draca and Van Reenen (2016)9 examined the impact of rising Chinese import competition on European firms over the period 1996-2007, and obtained similar results. They found that innovation increased more in those firms most affected by Chinese imports. And they found evidence of efficiency gains through two related channels: innovation increased and new existing technologies were adopted within firms; and aggregate productivity also increased because employment was reallocated towards more technologically advanced firms.

Wrapping up

On the whole, the available evidence suggests trade liberalization does improve economic efficiency. This evidence comes from different political and economic contexts, and includes both micro and macro measures of efficiency.

This result is important, because it shows that there are gains from trade. But of course efficiency is not the only relevant consideration here. As we discuss in a companion blog post, the efficiency gains from trade are not generally equally shared by everyone. The evidence from the impact of trade on firm productivity confirms this: "reshuffling workers from less to more efficient producers" means closing down some jobs in some places. Because distributional concerns are real it is important to promote public policies – such as unemployment benefits and other safety-net programs – that help redistribute the gains from trade.