Trade Openness and Economic Growth: A Panel Causality Analysis

Abstract

This paper examines the short-term and long-run dynamics between per capita GDP growth and openness for 158 countries over the period 1970-2009. We use panel cointegration tests and panel error-correction models (ECM) in combination with GMM estimation to explore the causal relationship between these two variables. We approach the problem of a potential endogeneity between openness and growth by including only growth rates and lagged values of the independent variable. Additionally, we apply Difference GMM and System GMM estimation. These estimators also address the issue of a possible correlation between the lagged endogenous variable and the error term. The results suggest a long-run relationship between openness and economic growth with a short-run adjustment to the deviation from the equilibrium for both directions of dependency. The long-run coefficients indicate a positive significant causality from openness to growth and vice versa, indicating that international integration is a beneficial strategy for growth in the long term. By contrast the short-run coefficient shows a negative short-run adjustment, suggesting that openness can be painful for an economy undergoing short-term adjustments. In addition to the entire panel we subdivide the data into income-related subpanels. While the long-run effect remains predominantly positive and significant, the short-run adjustment becomes positive when the income level increases. This result suggests that different trade structures in low-income and high-income countries have different effects on economic growth.

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