Trade and Economic Growth - Literature review Example

Trade and Economic Growth Over the years, the question of whether the liberation of policy does indeed promote economic growth has been a major topic of discussion that has featured prominently in the recent economic policy debates and considerations. With the onset of the new era of globalization in the wake of the 1990’s, what was known then as the Washington Consensus championed for what it termed openness to trade as the single most fundamental policy reform issue to enhance economic growth while stimulating higher incomes (Antoni and Taylor 2008, p.1). The intricate relationship between trade, particularly international trade and economic growth has been established over the years through various studies that have found that trade openness is without doubt a vital prerequisite for growth. However, despite the enormous body of literature that has been dedicated to this subject matter over the years, and the previously solid economic arguments that supported the conclusion that trade benefits the economy, there is still slight variations in the opinions of the economists today. A considerable body of literature on this matter today highlights that economic opinions on this issue are not yet unanimous, with some economists expressing scepticism that openness to trade automatically translates to economic growth. In that respect, this paper adds to the already swelled up discourse by examining whether indeed trade can lead to economic growth by critically evaluating empirical evidences of previous researches on the issue and integrating their arguments to establish a coherent perspective that can be backed by practical models of thriving economies. A considerable body of literature holds that the argument for lower trade barriers promoting the rapid economic improvement of developing countries is currently untenable given that existing evidence on the matter is inconclusive due to technical challenges in empirical investigations. In light of this view, both critics and proponents of the Washington Consensus have expressed regrets that its policies have not been very successful in producing the highly desired results in terms of accelerated economic growth. Ardent supporters of the Washington Consensus have acknowledged that economic growth has been below expectations, and in the case of the former socialist economies, the transition crisis has in fact worsened and persisted over the years. Artana (2009, p.16) remarks that even though the Washington Consensus has not disappeared in its entirety with the leading multilateral institutions such as the IMF and the World Bank strongly defending its policies, there are all indications that scepticism regarding the legitimacy of market fundamentalism exists. In this respect, a new wave of forces from local, national, as well as international levels has emerged challenging the premises of trade liberalization policies that inform the Washington Consensus as the fundamentals of economic growth while seeking alternatives to the same. As Weintraub (2009, p.29) puts it, the Washington Consensus resulted to both success and failures of the Latin America and the Caribbean; whereas the LAC economies experienced some considerable growth improvement under the elements of the Washington Consensus, their GDP growth rates declined a decade later. According to Lesay (2012 p.184), free trade and free investment flows as the strategies for growth have received too much undeserved attention at the expense of alternative and probably more workable economic growth strategies. The Post-Washington Consensus call is for the need to embrace a much comprehensive set of tools to achieve broader developmental goals in the form of improved living standards rather than mere increase in measured GDP. Stiglitz, one of the leading Post-Washington Consensus critics asserts that lack of competition rather than protectionism was initially causing stagnation in the global economies as proposed by the Washington Consensus. In as much as he acknowledges that granted trade liberalization might stimulate competition, this causal relationship is not automatic, implying that competition is neither necessary nor sufficient in creating competitive economies both in terms of imports and in terms of exports. Nonetheless, recent studies that have tried to overcome the numerous obstacles impeding reliability in previous experiments have been in favour of the 1990’s Washington Consensus, which promoted the lowering of tariffs to stimulate economic growth in the developing world. Theoretical foundations informing the Washington Consensus propose that low tariffs have the capacity of yielding not only affordable capital but also intermediate goods imports. Olajde Oladipo (2011 p.63) observes that Mexico moved towards an outward oriented trade regime in search of faster economic growth with remarkable success during its 1985 economic reforms agenda. The traditional economic theory was found on the premises that trade liberalization results to increased transactions, accelerated technological advancements, enhanced efficiency gains and eventually, economic growth. The trade liberalization theory, on the other hand, builds up from the classical theory that postulates that free trade generates economic efficiency thereby facilitating economic growth because it imposes numerous dynamic impacts on exports. Trade liberalization involves discarding the quota system and moving towards neutrality; long run economic growth in Mexico is largely attributable to trade liberalization and the level of capital investments. In this respect, this study seems to suggest that countries like Mexico have to take the chance of intensifying trade and investment reforms if they have to realize a sustainable and long run economic growth. Soukhakian (2007, p.1180) points out that the level of financial development, coupled with the degree of openness range among some of the critical macroeconomic variables that are highly associated with economic growth in many countries around the world. International trade leads to the expansion of money supply, which eventually stimulates an increased real income for both individuals and firms thereby promoting the expansion in foreign trade in terms of both exports and imports. The cumulative effect of the increased personal and firm incomes coupled with the expansion of trade is inevitably a fast growing economy that is sustainable in the end since it is based on real human and capital resources. International exchanges expand markets for the consumption of a country’s exports, thereby activating growth in economy that had deteriorated while stimulating development and prosperity in the country (Afaha, & Oluwatobi 2012, p.26). An export-led economic growth strategy calls for the streamlining of the numerous macroeconomic variables to create the conditions necessary for foreign trade to take place while limiting import trade. From the Nigerian experience in Africa, foreign trade involving the exchange of capital, goods, as well as services has been a major facilitator of economic growth and development since it increases foreign exchange earnings. Besides increasing foreign exchange earnings, foreign trade in the case of Nigeria has resulted to improved balance of debt repayment, increased employment, and the establishment of export based industries that specialize in manufacturing consequently expanding government revenue earnings through taxes, levies, as well as tariffs. Over the last two decades, the economic policies in Nigeria have been informed by trade liberalization as well as regional integration that have resulted to the elimination of trade barriers. However, overreliance on importation has largely been cited as one of the leading impediments to the influence of foreign trade on economic growth particularly because it damages local industries. Consistent with these findings concerning the Nigerian case, Chimobi (2010, p.146) contents that trade openness and financial development does, to a considerable extent, impose a causal impact on economic growth. The reverse is also true in that enhanced economic growth automatically boosts levels of trade and financial development as well; in this respect, it can be deduced that both trade and financial development stimulate the growth in GDP, thereby enhancing economic growth. Growth-led trade policies in developing nations have incredible capacity to help more of them to benefit from international trade as seen in the Nigerian case, whose market power has resulted from solid policy foundations. Generally, the relationship between trade liberalization and economic growth has often been conceptualized as either static or dynamic, with both approaches converging on the point that trade openness positively affects economic growth and vice versa. In that case, it appears that the relationship between trade liberalization and economic growth is bi-directional whereby countries restrict or open their economies in response to varying economic situations (Amadou 2013, p.155). Consistent with the theoretical perspective, results from an empirical work that examines the acceleration effects show that liberalization has actually succeeded in yielding meaningful growth benefits. These results goes a long way in establishing that liberalizers who took the initiative to lower their tariffs have experienced faster economic growth unlike the non-liberalizers who suffered considerable levels of stagnation (Antoni and Taylor 2008, p.30). Such conclusions are backed by evidential cases proving that capital as well as intermediate tariffs undermine the efficiency of states, while trade liberalizations have effectively unwound a majority, if not all of those inefficiencies over the years. Countries that have done away with tough restrictions to trade have benefited in terms of higher incomes per capita as well as lower inequality or poverty levels as a result of the accelerated growth rates; in this respect, there is no doubt that trade eventually leads to high economic growth rates. The pervasive policy perspectives in North America and Europe affirm that countries with lower barriers to international trade experience accelerated economic growth by drawing on the recent economic history in the regions (Rodriguez and Rodrik 2001, p.261). The World Bank and the IMF alongside other multilateral institutions of the world also believe that openness to trade is a fundamental factor that precipitates meaningful consequences for economic growth. The IMF in particular believes reaffirms the economics profession’s perspective that policies that promote international trade stimulate both economic growth and convergence in developing countries. With the implications of globalization such as conditioned global integration, it appears that counties can only survive and thrive by participating in the international order. In as much as previous researches have been faulted at various levels regarding their methods of investigation and their results discredited on the same lines, recent studies have indicated considerable scepticism regarding the alleged flaws. Across the world today, there is a widespread tendency for states to overstate systematic evidence in support of trade openness, and this has had remarkable impact on policy formulation in those particular countries. Consequently, the danger of such a move as expressed in expert criticisms is that states have eventually overlooked other institutional reforms that potentially have much greater payoffs than elimination of tariffs. In this respect, the view that integration into the world economy through trade liberalization is the single-most effective mechanism for boosting economic growth at the expense of deliberate development strategies seems farfetched. Trade does raise income levels by encouraging individuals to accumulate both physical and human capital while increasing the output for particular levels of capital (Frankel and Romer 1999, p.395); the economic growth theory analyses the evolution of real products and its distribution and asserts that economic growth stems from capital accumulation, population growth, and labour force availability. Following trade liberalization policies and the open market, the opportunities available for investment have also expanded and this eventually has translated to meaningful economic gains that lead to economic growth effectively. The resulting integration of states because of globalization inevitably enhances the productive effectiveness of states as the big market space accords them an accelerated rate of economic growth due to increased production and consumption. Openness of trade has long tern benefits to states particularly because in the liberalized system, international flows of factors of production such as capital promote the rate of convergence of states. Recent findings have attributed economic growth to endogenous innovation, which is because of international trade that stimulates the discovery of new inventions (Afonso 2001, p.15). Countries that experience growth of economies are better placed for economic development with improved living standards as well as equal distribution of wealth. According to Razmi and Rafaei (2013, p.376), international trade results to greater benefits for the citizens and firms in a country while production efficiency results from the production of goods and services under incentives that promote welfare. They further contend that international trade increases both consumer surplus (the variation between the price consumers are willing to pay and the price they end up paying) and producer surplus (the variation between the price producers are willing to give and what they end up paying). Due to its fundamental role in economic development, the concept of economic growth is of utmost importance to economists, who have spent considerable amount of time in trying to understand the fundamentals of economic growth, which ultimately result to the improvement of the living standards of the population. With the expansion of the global markets, international trade did become a very central factor in the propulsion of economic growth and economists have focused on the role of international trade in the growth of the economy for a long time. Economic freedom and trade liberalization in its entirety protects individual property right and accords individuals freedom to transact with whomever they choose on their own volition, while the presence of trade barriers does in effect limit these freedom thereby inhibiting entrepreneurship and productivity of both individuals and firms. By eliminating trade barriers through lowering tariffs, the government automatically provides incentives for individuals to engage in trade and other productive activities since they are guaranteed of gains from their engagement. According to the theories of international trade, openness to trade translates to higher national income for countries since studies have affirmed the findings that countries with the highest economic freedoms also have the highest incomes per capita unlike those that impose restrictions to trade. Liberalization of trade enhances welfare, thereby yielding specialization and exchange gains in the form of increased outputs in the short-run, and the productivity gains in the end are even much higher because of accelerated accumulation of new resources, which is made possible due to the higher savings potential that results from high productivity. Domestic firms acquire international market shares through enhanced welfare, thereby becoming as powerful as to prevent entry of other firms through price wars and this further increases their market shares across the world. The eventuality of this is that the firms are able to offer competitive lower prices for their products since they enjoy economies of scale as well as other dynamic gains that result due to the high entry cost, high learning cost, and other external factors in the protected industries. In that regard, there is no doubt as to whether government intervention in the form of subsidies enhances spillovers in the economy or not, as that has been proven over time. Consequently, positive spillovers in the economy account for the constant increase in the returns on accumulated human and physical resources thereby promoting the long run growth of the economy (Rodrik, 2006). Adhkary (2011, p.16) agrees with previous researches that the theoretical linkage between foreign direct investment, trade liberalization, capital accumulation, and economic growth has always been found to be positive. With particular focus on the degree of trade openness, this research points out that trade liberalization is more likely to influence the flows of international capital based on risk-return relationships in the global system. A critical point of concern is the increasingly dominant trend of investors shying off from countries that impose tough tariff restrictions on investment while complicating the deportation of capital and profits. As trade openness increases levels of transactions beyond national frontiers, this leads to high levels of capital formation, which in turn expands the much-needed finances for industrial growth and expansion, hence economic growth. Huan (2009 p.127) reiterates that whereas the expansion of production requires a continuously growing market, the growing market also promotes the expansion of production accordingly. Factors of production can be imported through international trade, and this importation of capital is crucial for promoting production in the manufacturing industries, which is the foundation for economic growth (Lee 1993, p.299). The success of Europe after 1500 has been associated with the growth in economies that had access to the Atlantic waters; in addition to that, the increased trade between Europe and new markets such as Africa and Asia has also been mentioned as one of the factors that instigated the growth (Acemoglu, Johnson & Robinson 2005, p.546). The nature of trade is also a vital determiner of the rate of economic growth; for instance, industries that engage in bilateral exchanges have a substantial impact on the economic growth rate while exchanges with leading economies generates even greater economic growth spillovers (Didier and Pinat 2013, p.25). Ultimately, there is indeed a considerable positive correlation between trade openness and the rate of economic growth in the end (Arif & Ahmad 2012, p.384); drawing upon the granger causality, there relationship between trade openness and economic growth is evidently bi-directional. References Antoni, E. and Taylor, A.M. 2008. “Is the Washington Consensus Dead? Growth, Openness and the Great Liberalization, 1970s-­‐2000s.” Working Paper 2007. Rodriguez, F. and Rodrik, D. 2001. “Trade Policy and Economic Growth: A Skeptic’s Guide to the Cross-­‐National Evidence.” Macroeconomics Annual, 2000. Frankel, J.A. and Romer, D. 1999. Does Trade Cause Growth? The American Economic Review, Vol. 89, No. 3, pp. 379-399. Afonso, O. 2001. The impact of international trade on economic growth. Available at: http://wps.fep.up.pt/wps/wp106.pdf Rodrik, D. (2006). Goodbye Washington Consensus, hello Washington Confusion? 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