Evidence for the Link Between Trade and Growth
Recognize why many economists believe that unrestricted free trade between nations will raise the economic welfare of countries that participate in a free trade system.
Many economic studies have looked at the relationship between trade and economic growth.16 In general, these studies suggest that as predicted by the standard theory of comparative advantage, countries that adopt a more open stance toward international trade enjoy higher growth rates than those that close their economies to trade. Jeffrey Sachs and Andrew Warner created a measure of how “open” to international trade an economy was and then looked at the relationship between “openness” and economic growth for a sample of more than 100 countries from 1970 to 1990.17 Among other findings, they reported:
We find a strong association between openness and growth, both within the group of developing and the group of developed countries. Within the group of developing countries, the open economies grew at 4.49 percent per year, and the closed economies grew at 0.69 percent per year. Within the group of developed economies, the open economies grew at 2.29 percent per year, and the closed economies grew at 0.74 percent per year.18
A study by Wacziarg and Welch updated the Sachs and Warner data through the late 1990s. They found that over the period 1950–1998, countries that liberalized their trade regimes experienced, on average, increases in their annual growth rates of 1.5 percent compared to pre-liberalization times.19 An exhaustive survey of 61 studies published between 1967 and 2009 concluded that: “The macroeconomic evidence provides dominant support for the positive and significant effects of trade on output and growth.”20
The message seems clear: Adopt an open economy and embrace free trade, and your nation will be rewarded with higher economic growth rates. Higher growth will raise income levels and living standards. This last point has been confirmed by a study that looked at the relationship between trade and growth in incomes. The study, undertaken by Jeffrey Frankel and David Romer, found that on average, a one percentage point increase in the ratio of a country’s trade to its gross domestic product increases income per person by at least one-half percent.21 For every 10 percent increase in the importance of international trade in an economy, average income levels will rise by at least 5 percent. Despite the short-term adjustment costs associated with adopting a free trade regime, trade would seem to produce greater economic growth and higher living standards in the long run, just as the theory of Ricardo would lead us to expect.22
• QUICK STUDY
1. What are the main differences among mercantilism, Adam Smith’s theory of absolute advantage, and David Ricardo’s theory of comparative advantage?
2. Why is the theory of comparative advantage so important in today’s world?
3. According to the theory of comparative advantage, what is the relationship between free trade and economic growth? Does the empirical evidence support this prediction?
4. What is the criticism that Paul Samuelson made of theories that advocate free trade?