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

Transcription

1 he Lnk between rade and Income: Export Effect, Import Effect, or Both? huo Zhang Department of Economcs tate Unversty of New York at Fredona Jan Ondrch J. Davd chardson 1 Department of Economcs yracuse Unversty February, 2004 Abstract hs paper presents a new framework to evaluate how cross-country dfferences n export openness and mport openness separately affect the real per capta ncome levels. Instrumental varable estmaton extracts the exogenous components of total trade and net exports, whch mply dstnct export and mport effects. We use countres geography as an nstrument for trade openness; and we buld on demography and cross-border transfers to develop a novel nstrument for net export openness. New estmates reveal that export alone correlates wth ncome, not mport. Ceters parbus, countres wth hgh export ntensty (but not hgh mport penetraton) have hgh ncome per capta. Keywords: Export; Import; rade; Income; Instrument JEL classfcaton: F41; F43 1 Zhang: Department of Economcs, E358 hompson Hall, Fredona, New York 14063; el.: ; Fax: ; zhangs@fredona.edu. Ondrch, chardson: Department of Economcs, 110 Eggers Hall, yracuse, New York 13244; el.: ; Fax: ; jondrch@maxwell.syr.edu; jdrchar@maxwell.syr.edu. All responsblty for errors remans wth the authors.

2 I. Introducton Mercantlsts beleved that trade surpluses enrched a country, and mplctly that ts government should encourage exports and restrct mports. Adam mth and Davd cardo challenged mercantlsm by argung that overall openness s what matters natons grow more prosperous through mports as well as exports. Many modern developng countres have replaced ther strategy of government-protected mport substtuton ndustralzaton wth an export orented strategy. hs paper re-poses the queston of whether trade openness rases a country s ncome per person (or per worker); and f t does, what are the channels and mechansms through whch trade affects ncome, n partcular through exports or through mports? 2 We buld on Frankel and omer (1999) and Irwn and ervö (2002). her papers allevated many of the conceptual and econometrc barrers to these ssues by showng how geographcal characterstcs provde an arguably good nstrument for a country s ntrnsc openness n a cross secton. Yet they admtted that ther approach could not separate the mport effect from the export effect. 3 No one to our knowledge has yet fgured a way to do what seems ntally the most natural next thng. hat s to construct a measure of export openness, then an arguably 2 Baldwn (2004) especally, but also Bosworth and Collns (2003) and OECD (2003) provded comprehensve lterature revews. ee also Zhang (2003). 3 We and Wu (2001) and We (2002a, 2002b) conscously followed smlar leads n a study of how globalzaton affects Chnese cty-level growth and nequalty. We conflated export and mport nfluences by selectng Chnese ctes dstance to two major Chnese ports as hs nstrument for a cty s natural openness. Hanson (2003), n somewhat the same sprt, found Mexcan wages hghest (ceters parbus) n regons that are geographcally and economcally closest to the Unted tates. 2

3 ndependent measure of mport openness, and nvestgate whether one has a dfferent effect on ncome across countres than the other, ceters parbus. hat s the prncpal objectve of ths paper to dentfy the separate nfluences of export openness and mport openness on ncome levels across countres n 1990 (as well as n 1985, 1980, and 1975). In partcular, we conceptualze and estmate an addtonal net trade effect on ncome levels. When combned wth Frankel and omer s total trade effect, the two effects together mply separable export and mport effects. 4 We fnd that export openness correlates much more closely and strongly wth a country s lvng standards cross-sectonally than does mport openness 5. he rest of the paper s as follows. ecton II descrbes the models and develops our approach, and ecton III reports the emprcal results. ecton IV tests the robustness of the fndngs. ecton V contans the conclusons of the paper. II. Emprcal pecfcaton We develop a smple model based on Frankel-omer (1999), separatng ther total trade share nto export share and mport share: ln( y ) η Z + ε (1) = 0 + η1x + η 2M + η3 where y represents the real per capta ncome for country. X and M are exports and mports scaled by real GDP. Z stands for other control varables. 4 Ondrch et al. (2002) explored the senstvty of the Frankel-omer approach to heteroscedastcty. Zhang (2003) examned the ssues of ths paper n a panel approach; see also Greenaway et al. (2002). 5 Unfortunately, the nstrumentng technques that we develop for net trade cannot be easly mplemented blaterally, so there remans some doubt about the exact conformty of our conclusons to Frankel and omer s. 3

4 here are two famlar problems wth smply estmatng equaton (1). One s the demandsde accountng relatonshp (Y = C + I + G + X M) coupled wth the supply-sde relaton between overall supply Y and export supply X. hus the key varables of nterest are mutually endogenous. he second problem s that export openness and mport openness are hghly correlated across countres, as every general-equlbrum thnker knows. And Country A s exports to country B are country B s mports from country A. o both measures of openness are endogenously related to each other and to ncome (per capta), the focus varable on whch they are thought to operate. 6 Confrontng these challenges, what s a researcher to do? Instrumental varable estmaton provdes a theoretcally appealng way to handle the endogenety problem. he mportant practcal queston posed n ths study s how to fnd two sets of nstruments that can not only capture the exogenous components of exports and mports but also dstngush the export effect from the mport effect. hs paper proposes an alternatve approach to dstngushng the effects of mports and exports n the sprt of nstrumental varables that meet the challenge of endogenety. Consder algebracally re-arrangng equaton (1). Let be total trade (exports plus mports) dvded by real GDP and let E be net trade (exports less mports) dvded by real GDP (to control for scale effects). Equaton (1) transforms to ln( y ) δ Z + ν. (2) = 0 + δ1 + δ 2E + δ 3 We argue that fndng good nstruments for and E n order to estmate equaton (2) across countres s much easer than fndng good nstruments for X and M n order to estmate 6 Focusng on the cases of Japan and Korea, Lawrence and Wensten (2001) found that mports rather than exports are the condut of faster productvty growth. However, we are not confdent that they adequately addressed the problem of reverse causaton. 4

5 equaton (1) cross-sectonally. Part of our approach rests on a comparson of Fgures 1 and 2. In Fgure 1, the average export share from 1970 to 1998 s plotted aganst the average mport share from 1970 to he World Development Indcator 2000 data cover 174 countres. he fgure exhbts an unsurprsng strong postve relatonshp between export share and mport share (wth a correlaton of 0.85). In Fgure 2, the sum of the export share and the mport share s plotted along the vertcal axs. Along the horzontal axs, we plot the dfference between the export share and the mport share. he chart shows no evdent relatonshp between the two varables n the long run (the correlaton s equal to ) Frankel and omer (1999) have already provded good canddates to nstrument for total trade share. he major contrbuton of ths paper s to propose nstruments for the net trade share varable that capture cross-country dfferences n remttances and n borrowng and lendng behavor, and the demographc and asset/portfolo varables underlyng such behavor. nce = X + M and E = X M, our estmaton approach wll shed mplct lght on the dstnctve export effect and the dstnctve mport effect. 7 A. Blateral rade egresson We adapt the approach and data of Frankel and omer (1999), as updated by Frankel and ose (2002), to employ geographcal characterstcs of countres as attractve cross-sectonal nstruments for total trade based on the gravty model of blateral trade. We accept ther demonstraton that countres geographcal features do affect ther trade, but are not affected by ther ncomes, by government polces, or by other factors that nfluence ncome. 7 We also further refne the Frankel-omer model wth a heteroscedastcty correcton descrbed brefly below and n more detal n Zhang (2003). 5

6 We follow ther specfcaton exactly, ncludng the usual gravty-equaton varables, as well as ndcators of landlocked status and common language and borders. We refne ther approach slghtly, due to the possblty of heteroscedastcty. We use weghted least squares estmaton based on the procedure proposed by Harvey (1976). As n Frankel and omer (1999), the predcted value of the overall trade share for country s aggregated from the predcted values of the blateral trade shares between country and all her tradng partners. 8 B. Net rade egresson Our man task n ths paper s to replace net trade (E) wth determnants n the sprt of nstrumental varables, then to nfer separate export and mport effects from ths and the Frankel- omer approach. Whle aspects of the tme-seres relatonshp between net exports and ncome are well-establshed, e.g., ts cyclcalty, the cross-secton relatonshp s not. What knd of natonal and nternatonal varables determne whch countres have overall trade surpluses and whch have overall trade defcts? What varables determne blateral net exports between two countres? And are those cross-sectonal determnants sutable for frst-stage nstruments n the current study, or do they too vary cross-sectonally wth ncome levels? hs sub-secton ams to answer. o begn, a country s current account balance conssts of three parts: (1) the balance of trade n goods and servces our E; (2) net rents, nterest, profts and dvdends represented as rb where B (-B) s the net foregn nvestment poston (a stock varable) that earns (pays) yearly nterest at some approprate nterest rate r; (3) transfer payments P such as foregn workers 8 ee some detals of the procedure n Appendx A1 and more n Zhang (2003). 6

7 remttances. In the open economy, the current account balance s also determned by the savngnvestment gap ( I), nclusve of government savngs/dssavngs. Changes n offcal reserves may offset any surplus or defct n the overall balance of the captal account KA and the current account CA. CA = E + rb + P = I = KA. (3) In prncple, equaton (3) descrbes both overall and blateral current-account balances. Blateral emprcal mplementaton of our approach unfortunately founders on data lmtatons. (Few natons or global data-collecton agences publsh more than a handful of the varables n equaton 3 on a blateral bass, ncludng the current account tself.) It s clear that we can re-wrte equaton (3) to conceve of E as determned crosssectonally by, I, r, B, remttances, and reserve changes. hough, I, and possbly r are also correlated wth ncome levels, and hence endogenous, transfer payments and reserve changes are less lkely to be. And there are at least some deeper determnants of and I themselves that mght qualfy as good nstrument canddates, especally n fnancally open economes. Wth respect to and I, n a closed economy wth zero nternatonal captal movement, savng s equal to nvestment. Economc growth depends on both savng and nvestment drectly. As countres open up, however, domestc nvestment s fnanced by the worldwde pool of savngs, whle domestc savng seeks the hghest returns n the global captal market. When domestc savng s not suffcent to fnance domestc nvestment, such as n the U.., the dfference s made up by foregn savngs. When domestc savng exceeds domestc nvestment, such as n Japan, the extra savngs are nvested abroad. Hgher savng s assocated wth captal outflow and lower savng ndcates captal nflow. hus, whle nvestment remans as a drect determnant of countres ncome level n the open market scenaro, global borrowng and 7

8 lendng mples that domestc savng alone s arguably detached from ts closed-economy nfluence on ncome. 9 hat n turn makes domestc savng or ts deeper determnants reasonably good canddates to nstrument for net trade (E). hough there s well-known skeptcsm over how open world captal markets really are, 10 almost all commentators agree that the degree of nternatonal captal moblty has ncreased sgnfcantly, especally durng the last years. he wdespread removal of captal controls n the ndustral countres enhanced fnancal ntegraton. he fnancal sector reforms and the openng up of the captal account to prvate captal nflows help to create lower and lower correlaton between domestc savng and nvestment, even n developng countres. 11 Hgh captal moblty allows us to use savng or factors that determne savng as nstruments for net trade or current account balance. 12 Yet the relatonshp between savng and net trade or current account balance reflects a complex nteracton of households, frms, and governments both at home and overseas. A random shock specfc to the net trade balance could 9 ee Kraay and Ventura (2002) for an up-to-date treatment and correspondng lterature. 10 Feldsten and Horoka (1980) orgnated the skeptcsm. ee Zhang (2003) and Kraay and Ventura (2002) for a revew. 11 Wth less dversfed producton and export structures, ol-exportng countres and small countres tend to have an especally low savng-nvestment correlaton. 12 Glck and ogoff (1995) showed that country-specfc shocks rather than global productvty shocks are mportant determnants of current account fluctuatons. Emprcal work extended dynamc optmzng models proposed by Ghosh (1995) and Ghosh and Ostry (1995) to the open economy context (azn 1995; Obstfeld and ogoff 1996). From a savng-nvestment perspectve, Debelle and Faruqee (1996) nvestgated the determnants of current account usng the structural approach. Holdng level of nvestment constant, countres wth a hgher savng rate tend to be net exporters and net mporters had a lower savng rate. 8

9 potentally affect a country s savng rato. 13 In order to avod these new endogenety problems, we propose countres demographc characterstcs as more fundamental and cleaner nstruments for net trade recognzng that dfferences of savng between two countres can be very well explaned by ther dfferences n demography. Demography matters n both age structure and n steady-state populaton growth. Wth regard to the former, lfe cycle models n an ntertemporal approach suggest that net trade balance s the outcome of forward-lookng dynamc savng and nvestment decsons. People save durng the earnng span at productve ages and dssave when they are young or old. hus, aggregate natonal savngs wll be relatvely hgh f the sze of the dependent populaton s low compared to the sze of the workng-age populaton. Hgh savngs buld up domestc and foregn assets, reflected n a large net trade surplus. In the cross-sectonal context, the real growth of output (GDP) s expected to have a postve mpact on the net trade balance due to the fast growng supply n the global market. We use the populaton growth rate as the proxy for the real growth of output to capture the mpact. Urbanzaton s also a deeper fundamental determnant of savng, lke demography, and s less lkely than savng tself to be subject to feedback nfluences from exogenous shocks to ncome. he trend toward urbanzaton leads to a lower prvate savng rate because precautonary savng s less necessary. 14 An mportant determnant of the net trade balance s the net nterest and nvestment ncome from abroad. A country can run a steady-state trade defct equal to her nvestment 13 For nstance, governments tend to adopt contractonary fscal polcy to prevent sustaned large captal flows when ther countres are n trade defct. 14 Edwards (1996); Loayza et al. (2000). 9

10 ncome, ceters parbus. Any deteroraton n nvestment ncome requres mprovement n the trade balance. Lkewse, nternatonal reserves flow nto the home country when t exports and flow out of the home country when t mports. Ceters parbus, a country can run a steady-state trade defct equal to ts declne n offcal reserves. Fnally, net current transfers from abroad, such as workers remttances, are an mportant source of foregn exchange for many countres that can fnance trade mbalances. he net trade balance s also nfluenced by a country s relatve prce of tradeable output to non-tradeable output (compared n turn to the comparable world prce rato). he hgher s a naton s relatve tradeables prce (by world standards), the larger wll be ts relatve output of both exportables and mport substtutes, output that gets exported n the frst nstance and dsplaces mports n the second (Obstfeld and ogoff 1996, pp ) Yet there s no obvous reason why a naton s ncome level should vary systematcally wth ths relatve prce, because every naton produces both tradeables and non-tradeables and earns ncome from both. 15 o summarze, we beleve the followng equaton to represent a strong, exogenous predcton of net exports: ˆ E = ˆ γ 0 + ˆ γ 1dep + ˆ γ 2 popg + ˆ γ 3ol + ˆ γ 4urpop ˆ + γ 5n ˆ + γ 6dres ˆ + γ 7relp ˆ + γ 8 nct. (4) 15 One could object that several of these varables, e.g., net remttances or returns on cross-border captal placement are co-determned endogenously wth net exports (E) as part of the deeper fundamentals of current account behavor how the current account sum of all of them, E, remttances, captal ncome, responds to shfts and shocks to output, nvestment prospects, and government spendng needs (Obstfeld and ogoff 1996, pp ). We agree, but can thnk of no feasble measures of global and country-specfc productvty and fscal shocks that could serve as deeper, more fundamental nstruments than those we choose. Furthermore, we thnk ths objecton relates more to net captal ncome and flows of offcal reserves than to remttances. 10

11 he dependent rato dep s calculated as the proporton of people under age 14 or over age 65. popg stands for the populaton growth rate. ol takes the value of 1 f country depends heavly on ol revenues as her man source of ncome. 16 urpop s defned as the percentage of the total populaton lvng n an urban locaton. n s the stock of net nvestment ncome from abroad as a rato of GDP, measured n year It captures the term rb n equaton (3). dres denotes changes n net offcal reserves as a rato of GDP. Prce relatve (relp) s measured as the rato of ratos of export prces to GDP deflators from 1985 to nct represents current transfers (from abroad), such as mgrants remttances, scaled by GDP. C. Income egresson he last step n re-askng the Frankel-omer queston, and n decomposng the effect of openness on per capta ncome nto an export and an mport effect, s to use the predcted values for the total trade share () and net export share (E) varables from sub-sectons A and B as nstruments n regresson equaton (5), and to estmate t across countres: ln( ) 0 + β1 + β 2E + β 3 ln( pop ) + β 4 y = β ln( area ) + u (5) where the dsturbance u represents all the uncertan factors that may also affect the level of the real per capta ncome. he sze of the coeffcents on and E determne f exports or mports are correlated more closely across countres wth per capta output. 16 he dummy varable for ol exportng countres (prmarly Gulf tates) s ncluded to capture several unque phenomena. One s the unusually low savngs-nvestment correlaton descrbed n note 12; another s strkngly large ntra-regonal and nternatonal mgraton. he dummy varable for ol exportng countres s expected to be postve snce these countres typcally have a more favorable current account poston on average (Chnn and Prasad 2003). 11

12 Λ ln( y ) ˆ ( ˆ ˆ ) ( ˆ ˆ ) ˆ ln( ) ˆ = β 0 + β1 + β 2 X + β1 β 2 M + β 3 pop + β 4 ln( area ) (6) where ˆ β ˆ 1 + β 2 measures the predcted partal effect of exports on per capta ncome and ˆ β ˆ 1 β 2 measures the predcted partal effect of mports on per capta ncome, holdng the sze of countres constant. he relatve mportance of exports and mports depends on the sgn and magntude of ˆ β 1 and ˆβ 2 estmated for equaton (6). he estmaton results are shown n ecton III (data are descrbed n the appendces). III. Estmaton esults A. Blateral rade egresson We start by testng for heteroscedastcty n the Frankel-omer (1999) blateral trade regresson by runnng the Breusch-Pagan test on a regresson of log squared OL resduals on the blateral trade regressors. he resultng test statstc of s hghly sgnfcant statstcally (p value = ). Accordngly, the null hypothess of homoscedastcty s rejected. We therefore use the weghted least squares (WL) approach proposed by Harvey (1976), where the 2 square of the weght (error varance σ ) s constructed as the exponental functon of the predcted e ˆ. All the varables n the regresson are weghted by the nverse of the square root 2 ln of the varance. WL regresson results n able 1 reveal a postve and statstcally sgnfcant relatonshp between blateral trade and country s geographc characterstcs. All else beng equal, large dstance leads to less trade. If the offcal languages n country and country j are the same, trade rses by 55 percent. wo countres that share a border trade 62 percent more than countres pars whch do not. Landlocked countres tend to trade less due to hgh transportaton 12

13 costs. A sgnfcant porton of the varaton of the blateral trade share s explaned by the estmated equaton. he Frankel-omer results are thus confrmed, usng a larger sample. 17 B. Net rade egresson he results of ths paper rest crucally on our approach to net exports. he net exports regressons are estmated for eght dfferent sets of varables to control for countres demographc characterstcs and cross-border transfers features. able 2 provdes the results of the estmaton based on equaton (5). he results of the frst specfcaton ndcate that an ncrease n the age dependency rato leads to a reducton n net trade, as expected. he mpact of populaton growth rate s postve but not sgnfcant. Controllng for country s demography, ol-exportng countres do tend to have a hgher net trade share relatve to non-ol-exportng countres. he second specfcaton adds the urban populaton rato varable. he urban populaton rato s postvely related to the net trade balance at a 10% sgnfcance level, as opposed to our hypothess. Alternatve specfcatons exclude the urban populaton rato from the regresson; the results for other coeffcents reman largely unchanged. In specfcaton (3), we emphasze fnancal-transfer factors alone. As expected, net nvestment ncome from abroad has a sgnfcant and negatve mpact on net export share. Changes n reserves and the relatve prce of tradeables do not appear to play a major role n 17 Data on blateral trade are only avalable for 62 countres n the Frankel and omer (1999) study. Based on the coeffcents estmated from the gravty model, Frankel and omer mputed the blateral trade share for country pars whose recorded trade share s mssng. he qualty of the nstruments and the precson of the estmated effects are brought nto queston especally f the gravty relaton s systematcally dfferent for countres n the sample than for countres added through mputaton. 13

14 determnng the trade balance, possbly because of the non-market forces n some planned economes that make t dffcult for nternatonal trade flows to adjust to changes n market condtons. Net current transfers are statstcally sgnfcant n explanng the trade balance. A one percentage pont ncrease n net current transfers s assocated wth a 1.14 percentage pont decrease n the net trade share balance. In specfcatons (4) to (8), we combne the two sets of nstruments, demographc and fnancal. hese specfcatons dffer n two aspects: () whether or not the urban populaton rato ncluded; () the two alternatve measures of current transfers consdered (current transfers from abroad and net workers remttances.) In most cases, countres net exports balance sgnfcantly mproves wth the lower dependency rato, hgher urban populaton rato, lower net ncome from abroad, or lower net current transfers. hese fndngs are consstent wth our hypothess. Alternatve measures of net current transfers do not seem to alter the results. he bnary varable for ol-exportng countres s assocated wth the net trade balance at the 1% sgnfcance level, whle we do not fnd a sgnfcant relatonshp between countres trade balance and the populaton growth rate, changes n reserves, or the relatve prce of tradeables. he varous specfcatons predct between 14% and 80% of the overall varaton n the net export share. C. Income egresson In order to cope wth the smultanety between openness and ncome, the ncome equaton s estmated usng nstruments for total and net trade that come from geography, demography, and cross-border transfers, as descrbed n the prevous two sub-sectons. he objectve of ths sub-secton s to test whether, after controllng for the sze of the economy, total 14

15 trade openness and net trade openness contrbute to explanng cross-country dfferences n the level of real per capta ncome. o nvestgate the qualty of the nstruments, the scatter plot matrces n the eght panels of Fgure 3 vsually dentfy the relatonshp between the trade varables and ther predcted values. Next to the correlaton matrces, numercal values of the correlatons are dsplayed n the correlaton tables. Overall, Fgure 3 shows that total trade share s postvely lnked wth the aggregaton of the estmated blateral trade equatons; correlatons range from 0.53 to egardng net exports, we fnd that the actual values are n general postvely correlated wth predcted values, wth correlatons rangng from 0.51 to Consderable nformaton about countres overall trade and trade balance s provded by the predcted values wth no apparent outlers. he correlaton between the total trade share and the net trade share, as well as the correlaton between the predcted total trade share and the predcted net trade share, are weak and nonlnear, as desred, mplyng that collnearty s probably not a problem, agan as desred. able 3 presents eght two-stage least squares estmaton results for the lnk between openness and per capta ncome, one for each of the eght specfcatons of the frst stage net trade balance estmaton. he frst column reports OL estmaton results that serve as a benchmark. he prmary focus of ths table s the coeffcent estmates of the total trade share and net trade share. When controllng for the sze of the economy, we fnd that hgher levels of the net trade share only are typcally lnked wth more per capta ncome. he sze of countres, as measured by populaton and area, has an nsgnfcant effect. 18 able 3 shows that these regressons account for 28 to 60 percent of the cross-country varaton n per captal real GDP. 18 hs suggests that the man nfluence of geography on ncome s through the channel of nternatonal flows of goods and servces, rather than the wthn-country trade. 15

16 he man results on the coeffcents estmates for and E from able 3 are solated n able 4. An F-test s used to fnd the jont sgnfcance of the coeffcents on and E. he test statstcs reject the hypothess that both coeffcents n row 1 and 2 are zero, supportng that the per capta ncome s assocated wth both the total trade share and the net trade share. Impled coeffcents for the separate effects on per capta ncome of export openness and mport openness appear n the last two rows. Coeffcents of X n row 4 are the sum of the row 1 coeffcents on and the row 2 coeffcents on E. Coeffcents of M n row 5 are the dfference between the row 1 coeffcents on and the row 2 coeffcents on E. he correspondng standard errors for the coeffcent sums/dfferences are computed and recorded n the parenthess. he coeffcents for X change moderately across the eght specfcatons, but reman postve and hghly sgnfcant. he coeffcents for M are negatve and margnally sgnfcant. able 4 leads to three man conclusons. Frst, the more generally open a country, the hgher per capta ncome, ceters parbus (the Frankel-omer concluson). 19 econd, mport openness alone s ether uncorrelated wth per capta ncome, or negatvely correlated. 20 o put the pont quanttatvely, comparable and equally open countres by the Frankel-omer 19 he combned export-openness and mport-openness effect n the expanded model of ths study (approxmately 0.01) appears to be much smaller than the trade-openness effect estmated n Frankel and omer (1999) and Ondrch et al. (2002) (approxmately 1 to 2). Frankel and omer (1999), as well as Ondrch et al. (2002), dvded both the actual and the constructed trade share by 100, whch causes the dscrepancy. he nterpretaton of the coeffcent estmates remans consstent, even though t depends on how the trade share varable s scaled. An ncrease n fr,.e., (X + M) / 100, of one percentage pont s assocated wth a 1 percent ncrease n ncome per person. An ncrease n (X + M) of one percentage pont s assocated wth a 0.01 percent ncrease n ncome per person. 20 Very smlar results emerge mplctly from Mller and Upadhyay s (2000) s study of the effect of openness on a country s total factor productvty (ntmately related, of course, to ts ncome per person). her trade orentaton measure, based on the countres devatons from Purchasng-Power-Party exchange rates proxes for mport shares. 16

17 measure but that dffer between themselves n X-openness and M-openness have dfferent per capta GDP; those that are 1 percent more X-open than M-open have approxmately 0.1 hgher GDP per person. hrd, the postve export openness effect s greater than the negatve mport openness effect n all cases. IV. obustness ests o test the relablty of the emprcal fndngs, ecton III estmatons are carred out for year 1975, 1980, and he frst stage blateral trade regresson s specfed as outlned above and n Frankel and ose (2002). Instruments used n the frst stage net trade share regressons correspond to specfcatons (1) through (8) n able 2. Coeffcents and standard errors for all openness ndcators are summarzed n ables 5, 6, and Each table s n the style of able 4. he results demonstrated are mostly stable n sgnfcance and quanttatvely smlar across dfferent tme perods. Gven the excluson of numerous economes for whch data are not avalable at the blateral level, the 1975 cross-secton estmates appear to be less precse. he man results n ecton V are confrmed. he export share varable retans ts magntude, sgn, and strong sgnfcance. he fndng suggests that export s the prmary path through whch openness determnes ncome. hs s consstent wth typcal emprcal estmates n the export-led-growth lterature. he estmated mport share contnues to ndcate the weak assocaton between mport and ncome. he sgn of the coeffcent s negatve, suggestng that mports may undermne the overall effectveness of openness and globalzaton. 21 he frst stage regresson results for year 1975, 1980, and 1985 are avalable upon request. 17

18 V. Concludng emarks How does openness correlate wth per capta ncome? And does t matter whether ts ndcator s export openness or mport openness? he man contrbuton of ths study s the development of an ntegrated two-stage framework to these questons, as descrbed below: Exports Cross-border ransfers Geography otal rade Income Net rade Demography 1st stage 2nd stage 2nd stage 1st stage Imports We develop nstruments to estmate cross-sectonally both the export-ncome lnkage and the mport-ncome lnkage. o address the smultanety problem, we employ an nstrumental-varable approach to cross-country varatons n the overall trade share, relyng on geographc factors, as others have done, and to cross-country varatons n the net trade share (exports mnus mports), emphaszng demography as well as cross-border fnancal transfers. he nfluence of export openness and mport openness on ncome s nferred through the nteracton of the total trade effect and the net trade effect. Our cross-sectonal estmaton ndcates a postve correlaton between export openness and ncome levels. Import openness correlates negatvely wth countres ncomes, however, though sgnfcantly dfferent from zero n only half our runs. When sgnfcant, the negatve mport openness effect s always quanttatvely smaller than the postve export openness effect. aken together, ths leads the total-trade-openness effect export openness plus mport openness to be postve, whch s n lne wth the emprcal predctons from other research n ths genre. 18

19 In a provsonal panel extenson of ths paper, Zhang (2003) found that the exogenous components of export openness are postvely assocated wth ncome levels and are hghly sgnfcant after controllng for possble reverse causalty from ncome to exports. he mport openness effect s postve and nsgnfcant most of the tme (whereas t s often negatve n the cross-sectons). he favorable export effect s larger than the favorable mport effect, when sgnfcant. Appendx A1 wo-tep Procedures he nstrumental varable analyss for the total trade share n ths paper s generalzed nto the followng two steps: A1.1 tep I ---- Blateral trade regresson In step I, we regress the log blateral trade share (t ) on countres geographcal features represented by dstance (dst ), tradng partner s populaton (pop j ), product of areas (area area j ), common language dummy (langauge ), common border dummy (border ), and landlocked dummy (landlocked ). ln t = ln( τ / GDP ) = α ' X + e = a0 + a1 ln( dst ) + a2 ln( pop j ) + a3 ln( area area j ) + a4 language + a 5 border + a6landlocked + e. (a1) where e 2 = ln t α ' X, e ~ N(0, σ ). 19

20 Harvey s (1976) procedure s used to correct for heteroscedastcty. We assume that the varance of the dsturbance term e n equaton (a1) takes the followng form: σ 2 = exp(λ'x ). (a2) he estmator of λ s the OL estmator 1 ˆ = X ' X ln(ˆ e 2 j j λ X ), (a3) of the coeffcent vector n the regresson 2 eˆ ln ( ) = λ'x + η (a4) where 2 e ˆ s the square of the resdual resultng from the OL regresson of equaton (a1) and η s the dsturbance term. A1.2 tep II ---- otal trade constructon γ n In a heteroscedastc model, one should use nonlnear least squares regresson to estmate t = exp(γ ' X ) exp( aˆ' X ) + u, (a5) and set ˆ γ = exp( ˆ' γ X ). (a6) he predcted overall trade share for country s: ˆ = ˆ γ exp( aˆ' X ). (a7) j ee Zhang (2003). A2 Data Descrpton 20

21 A2.1 Blateral rade Data et he blateral trade data are obtaned from Andrew ose web ste. hs data set ncludes blateral trade shares, dstance between countres, populaton, area, a common-language dummy varable, a common-border dummy varable, and a landlocked dummy varable for 186 countres n year ose s orgnal source for the trade data s the World rade Database and Unted Naton s Internatonal rade tatstcs Yearbook. he populaton and real GDP per capta data come from Penn World able 5.6. Area data are from the World eference Atlas. he nformaton for the dstance and common language dummy varable s from the Central Intellgence Agency (CIA) s web ste. A2.2 Net rade Data et he net trade data ncludng exports, mports, GDP, populaton aged 0-14, populaton aged 65 and above, total populaton, populaton growth rate, net ncome, changes n net reserves, GDP at market prces, offcal exchange rate, and current transfers are taken from World Bank s World Development Indcator Net ncome from abroad ncludes the net labor ncome and net property entrepreneural ncome components of the system of natonal accounts (NA). Changes n net reserves are the net change n a country s holdngs of nternatonal reserves resultng from transactons on the current, captal, and fnancal accounts. he net current transfers take three forms. he net current transfers from abroad comprse transfers of ncome between resdents of the reportng country and the rest of the world that carry no provsons for repayments. he net current transfers are recorded n the balance of payments whenever an economy provdes or receves goods, servces, ncome, or fnancal tems wthout a qud pro quo. 21

22 he thrd measure comes from the net workers remttances as recorded by Internatonal Monetary Fund s Balance of Payments tatstcs. he relatve prce of tradeables s calculated based on the data obtaned from the World Bank s World able. We defne the prce relatve as the 1990 to 1985 rato of export-to-gdpdeflator prce ndces. nce the export prce ndex s n terms of the 1987 current U dollars whle the GDP deflator s n 1987 local currences, we create an exchange rate ndex for both year 1990 and year 1985 to adjust the prces nto the same currences. In partcular, (exchange rate ndex) t (exchange rate) 100 (exchange rate) t = (a8) 1987 where t refers to year 1985 or herefore, 1990 to 1985 rato of export-to-gdp-deflator prce ndces (export prce ndex) 1990 = (GDP deflator) 1990 /(exchange rate ndex) (export prce ndex) 1985 (GDP deflator) 1985 /(exchange rate ndex) (a9) he data on the offcal exchange rate are taken from the World Development Indcator Ol-exportng country lst ncludes eleven OPEC member countres (Algera, Lbya, Ngera, Indonesa, Iran, Iraq, Kuwat, Qatar, aud Araba, the Unted Arab Emrates), addtonal Gulf Cooperaton Councl countres (Oman, Bahran), and other non-opec ol producng countres (ussa, Norway, Mexco). A2.3 Income Data et Data on trade, GDP, populaton, and area for the ncome regresson are also taken from the Andrew ose web ste. hs data set conssts of the year 1990 observatons for

23 countres from the World Development Indcators 2000, merged wth data from the Penn World able 5.6. A3 ummary tatstcs for the otal rade hare egresson A3.1 General tatstcs Varable Obs. Mean td. Dev. Mn Max blateral trade share e dstance populaton j area area j e e e+14 language border landlocked A3.2 Varable Descrpton Varable Descrpton blateral trade share Blateral trade value dvded by real GDP dstance he great crcle dstance between the prncple ctes of country and j populaton j Country j s populaton n 000 s area area j Product of real areas. language 1 for common offcal language between country and j border 1 for common land border between country and j landlocked Number of landlocked countres n par (0, 1 or 2) Data source: Frankel and ose (2002). A4 ummary tatstcs for the Net rade hare egresson A4.1 General tatstcs Varable Obs. Mean td. Dev. Mn Max Net trade share Age dependency rato Populaton growth rate Ol-exportng countres Urban populaton rato Net ncome from abroad Changes n reserves elatve prces Net current transfers from abroad Net current transfers emttances

24 A4.2 Varable Descrpton Varable Descrpton Net trade share 1990 Net trade dvded by real GDP Age dependency rato 1990 Populaton aged populaton aged 65 and above (% of total) Populaton growth rate 1990 Populaton growth (annual %) Ol-exportng countres 1 for OPEC, Abab-OPEC, and non-opec countres Urban populaton rato 1990 Urban populaton (% of total) Net ncome from abroad 1990 net ncome from abroad (% of GDP) Changes n reserves Net changes n reserves (% of GDP) elatve prces 1990 to 1985 rato of export-to-gdp-deflator prce ndces Net current transfers 1990 net current transfers (% of GDP) Net current transfers from abroad 1990 net current transfers from abroad (% of GDP) emttances 1990 Workers remttances (% of GDP) Data source: Frankel and ose (2002). World Development Indcators Internatonal Monetary Fund Balance of Payments tatstcs World Bank able. A5 ummary tatstcs for the Income egresson A5.1 General tatstcs Varable Obs. Mean td. Dev. Mn Max Per capta GDP otal trade share Net trade share Populaton Area e+07 A5.2 Varable Descrpton Varable Descrpton Per capta GDP eal per capta GDP chan ndex otal trade share otal trade dvded by real GDP Net trade share Net trade dvded by real GDP Populaton Populaton n 000 s Area Area n sq. km. Data source: Frankel and ose (2002). World Development Indcators Bblography Baldwn,.E., 2004, Openness and Growth: What s the Emprcal elatonshp?, n: Baldwn,.E., Wnters, L.A. (Eds.), Challenges to Globalzaton: Analyzng the Economcs. he Unversty of Chcago Press, Chcago, pp

25 Bosworth, B., Collns,.M., 2003, he Emprcs of Growth: An Update. Manuscrpt. he Brookngs Insttuton, Washngton, D.C.. Chnn, M., Prasad, E.., 2003, Medum-erm Determnants of Current Accounts n Industral and Developng Countres: An Emprcal Exploraton. Journal of Internatonal Economcs 59(1), Debelle, G., Faruqee, H., 1996, What Determnes the Current Account? A Cross-ectonal and Panel Approach. Internatonal Monetary Fund Workng Paper No. 96/58. Edwards,., 1996, Why Are Latn Amerca s avngs ates o Low? An Internatonal Comparatve Analyss. Journal of Development Economcs 51(1), Feldsten, M., Horoka, C., 1980, Domestc avng and Internatonal Captal Flows. he Economc Journal 90(358), Frankel, J.A., omer, D., 1999, Does rade Cause Growth?. Amercan Economc evew 89, Frankel, J.A., ose, A.K., 2002, An Estmate of the Effect of Common Currences on rade and Income, Quarterly Journal of Economcs 117(2), Ghosh, A., 1995, Internatonal Captal Moblty Amongst the Major Industralzed Countres: oo Lttle or oo Much?. he Economc Journal 105, Ghosh, A.., Ostry, J.D., 1995, he Current Account n Developng Countres: A Perspectve from the Consumpton-moothng Approach. World Bank Economc evew 9,

26 Glck,., ogoff, K., 1995, Global versus Country-pecfc Productvty hocks and the Current Account. Journal of Monetary Economcs 35, Greenaway, D., Morgan, W.C., Wrght, P.W., 2002, rade Lberalzaton and Growth n Developng Countres. Journal of Development Economcs 67(1), Hanson, G., 2003, What Has Happened to Wages n Mexco nce NAFA?. Natonal Bureau of Economc esearch Workng Paper No Harvey, A.C., 1976, Estmatng egresson Models wth Multplcatve Heteroscedastcty. Econometrca 44(3), Irwn, D.A., ervö, M., 2002, Does rade ase Income? Evdence from the wenteth Century. Journal of Internatonal Economcs 58(1), Kraay, A., Ventura, J., 2002, Current Accounts n the Long and the hort un. Natonal Bureau of Economc esearch Macroeconomcs Annual 2002, Cambrdge, Massachusetts, pp Lawrence,.Z., Wensten, D.E., 2001, rade and Growth: Import-led or Export-led? Evdence from Japan and Korea, n tgltz, J.E., Yusuf,. (Eds.), ethnkng the East Asan Mracle. Oxford Unversty Press, Oxford. Loayza, N., chmdt-hebbel, K., erven, L., 2000, What Drves Prvate avngs Across the World?. he evew of Economcs and tatstcs 82(2), Mller,.M., Upadhyay, M.P., 2000, he Effects of Openness, rade Orentaton, and Human Captal on otal Factor Productvty. Journal of Development Economcs 63,

27 Obstfeld, M., ogoff, K., Foundatons of Internatonal Macroeconomcs. Massachusetts Insttute of echnology Press, Cambrdge, Massachusetts. OECD (Organzaton for Economc Cooperaton and Development), 2003, he ources of Economc Growth n the OECD Countres, Pars. Ondrch, J., chardson, J.D., Zhang,., 2002, Further Investgaton of the Lnk between rade and Income. Workng Paper, yracuse Unversty. azn, A., 1995, he Dynamc-Optmzng Approach to the Current Account: heory and Evdence, n Kenen, P. (Eds.), Understandng Interdependence: he Macro-economcs of the Open Economy. Prnceton, New Jersey. We,., 2002a, Is Globalzaton Good for the Poor n Chna?. Fnance and Development 39(3), We,., 2002b, Chna as a Wndow to the World: rade Openness, Lvng tandards and Income Inequalty, n Gruen, D., O Bren,., Lawson, J. (Eds.), Globalzaton, Lvng tandards and Inequalty. eserve Bank of Australa and Australan reasury, Canberra, pp We,., Wu, Y., 2001, Globalzaton and Inequalty: Evdence from Wthn Chna. Natonal Bureau of Economc esearch Workng Paper No Zhang,., 2003, hree Essays on the Emprcal Lnkage between rade and Income. Unpublshed Doctoral Dssertaton, yracuse Unversty. 27

28 able 1: Blateral rade hare and Geography, 1990 Dependent varable: ln (blateral trade share) Ln (dstance ) -1.21*** (0.03) Ln (populaton j ) 1.01*** (0.02) Ln (area area j ) -0.29*** (0.01) Language 0.55*** (0.08) Border 0.62*** (0.15) Landlocked -0.70*** (0.06) Constant -0.58* (0.33) Number of Observatons E of regresson 2.28 tandard errors recorded n parentheses. he symbols *, **, *** ndcate statstcal sgnfcance at the 10%, 5%, and 1% levels, respectvely. 28

29 able 2: Net rade hare, Demography, and Cross-Border ransfers Characterstcs, 1990 Dependent varable: net export share (1) (2) (3) (4) (5) (6) (7) (8) Dependency rato -0.73** (0.28) (0.36) (0.15) 0.09 (0.18) -0.65*** (0.19) -0.43** (0.22) 0.13 (0.41) Populaton growth rate 0.93 (1.59) 0.60 (1.59) (0.82) (0.82) 1.52 (1.14) 1.51 (1.11) (2.10) Ol-exportng countres 14.39*** (4.64) 12.16** (4.79) 4.26** (2.09) 3.56* (2.12) 8.10*** (2.39) 6.86*** (2.40) 9.28** (3.61) Urban populaton rato 0.13* (0.07) 0.05* (0.03) 0.08** (0.04) 0.15* (0.07) Net ncome from abroad -0.79*** (0.10) -0.64*** (0.14) -0.59*** (0.14) -0.69*** (0.19) -0.58*** (0.19) -0.67** (0.26) Changes n reserves -0.35* (0.19) (0.17) (0.17) -0.45* (0.24) -0.45* (0.24) 0.15 (0.34) elatve prce (1.64) 0.23 (1.35) 0.47 (1.35) (2.10) (2.05) (2.74) Net current transfers -1.14*** (0.10) -1.03*** (0.10) -1.02*** (0.10) Net transfers from abroad -0.70*** (0.13) -0.68*** (0.13) Net remttances -0.84*** (0.28) Constant 22.30** (9.94) (16.08) (1.73) 2.04 (5.34) (7.49) 21.01*** (6.57) 7.91 (8.87) (17.12) Number of Observatons E of regresson obust standard errors recorded n parentheses. he symbols *, **, *** ndcate statstcal sgnfcance at the 10%, 5%, and 1% levels, respectvely. 29

30 able 3: otal rade hare, Net rade hare, and Per Capta Income, 1990 Dependent varable: ln (per capta real GDP) OL IV (1) IV (2) IV (3) IV (4) IV (5) IV (6) IV (7) IV (8) otal trade share 0.005*** (0.002) (0.007) (0.007) (0.017) (0.012) (0.011) (0.010) (0.010) 0.096* (0.054) Net trade share 0.029*** (0.009) 0.147*** (0.044) 0.150*** (0.035) 0.046** (0.016) 0.068*** (0.016) 0.072*** (0.016) 0.102*** (0.038) 0.112*** (0.035) (0.058) Ln (populaton) 0.10 (0.08) 0.00 (0.10) 0.00 (0.11) 0.12 (0.18) 0.12 (0.14) 0.11 (0.14) 0.03 (0.12) 0.02 (0.12) 0.97* (0.50) Ln (area) (0.07) (0.13) (0.13) 0.17 (0.14) 0.10 (0.20) 0.10 (0.12) (0.18) (0.17) 0.31 (0.36) Constant 7.57*** (0.77) 8.83*** (2.17) 8.93*** (2.04) 3.32 (3.42) 4.65* (2.59) 4.82* (2.57) 7.96** (3.16) 8.38*** (2.98) (11.49) Number of Observatons ME obust standard errors recorded n parentheses. he symbols *, **, *** ndcate statstcal sgnfcance at the 10%, 5%, and 1% levels, respectvely. able 4: he Impact of Export hare and Import hare on Per Capta Income, 1990 Coeffcent estmates OL IV (1) IV (2) IV (3) IV (4) IV (5) IV (6) IV (7) IV (8) otal trade share 0.005*** (0.002) (0.007) (0.007) (0.017) (0.012) (0.011) (0.010) (0.010) 0.096* (0.054) Net trade share 0.029*** (0.009) 0.147*** (0.044) 0.150*** (0.035) 0.046** (0.016) 0.068*** (0.016) 0.072*** (0.016) 0.102*** (0.038) 0.112*** (0.035) (0.058) F test (0.003) (0.009) Export share 0.035*** (0.009) 0.151*** (0.037) 0.154*** (0.03) 0.076*** (0.021) 0.085*** (0.017) 0.089*** (0.018) 0.109*** (0.030) 0.117*** (0.029) 0.135*** (0.040) Import share ** (0.009) *** (0.048) *** (0.040) (0.026) ** (0.022) ** (0.022) ** (0.046) ** (0.043) (0.104) obust standard errors recorded n parentheses. he symbols *, **, *** ndcate statstcal sgnfcance at the 10%, 5%, and 1% levels, respectvely. 30

31 able 5: he Impact of Export hare and Import hare on Per Capta Income, 1985 Coeffcent estmates OL IV (1) IV (2) IV (3) IV (4) IV (5) IV (6) IV (7) IV (8) otal trade share 0.009*** (0.002) (0.019) (0.014) 0.035** (0.016) 0.033** (0.015) 0.032** (0.014) 0.017* (0.010) 0.017* (0.009) 0.069* (0.037) Net trade share 0.024*** (0.006) 0.147*** (0.075) 0.157*** (0.050) 0.035* (0.019) 0.044** (0.020) 0.050*** (0.019) 0.135*** (0.022) 0.137*** (0.022) (0.066) F test (0.002) Export share 0.033*** (0.006) 0.153*** (0.058) 0.161*** (0.040) 0.070*** (0.019) 0.076*** (0.017) 0.082*** (0.017) 0.152*** (0.021) 0.154*** (0.021) (0.036) Import share ** (0.007) (0.092) ** (0.062) (0.029) (0.030) (0.028) *** (0.027) ** (0.027) (0.101) obust standard errors recorded n parentheses. he symbols *, **, *** ndcate statstcal sgnfcance at the 10%, 5%, and 1% levels, respectvely. Frst stage blateral trade regresson nstruments: ln (dstance), ln (populaton), ln (product of area), common language dummy, common border dummy, and landlocked dummy. Frst stage net trade regresson nstruments: age dependency rato, populaton growth rate, ol-exportng country dummy, urban populaton rato, net ncome from abroad, changes n offcal reserves, relatve prce of tradeables, net current transfers (from abroad), and net workers remttances. able 6: he Impact of Export hare and Import hare on Per Capta Income, 1980 Coeffcent estmates OL IV (1) IV (2) IV (3) IV (4) IV (5) IV (6) IV (7) IV (8) otal trade share 0.002*** (0.001) (0.008) (0.010) 0.014** (0.001) 0.017** (0.007) 0.016** (0.007) 0.015* (0.009) 0.015* (0.009) (0.010) Net trade share 0.028*** (0.006) 0.076*** (0.020) 0.077*** (0.028) 0.046*** (0.009) 0.039*** (0.009) 0.043*** (0.009) 0.137*** (0.030) 0.140*** (0.029) 0.055*** (0.015) F test Export share 0.031*** (0.006) 0.089*** (0.016) 0.090*** (0.020) 0.060*** (0.011) 0.057*** (0.012) 0.059*** (0.012) 0.152*** (0.021) 0.155*** (0.030) 0.069*** (0.010) Import share *** (0.007) ** (0.026) * (0.037) *** (0.011) * (0.012) ** (0.012) *** (0.032) *** (0.031) ** (0.023) obust standard errors recorded n parentheses. he symbols *, **, *** ndcate statstcal sgnfcance at the 10%, 5%, and 1% levels, respectvely. Frst stage blateral trade regresson nstruments: ln (dstance), ln (populaton), ln (product of area), common language dummy, common border dummy, and landlocked dummy. Frst stage net trade regresson nstruments: age dependency rato, populaton growth rate, ol-exportng country dummy, urban populaton rato, net ncome from abroad, changes n offcal reserves, relatve prce of tradeables, net current transfers (from abroad), and net workers remttances. 31