Trade Openness and Economic Growth: Search for a Causal Relationship

By Hassan, A. F. M. Kamrul | South Asian Journal of Management, October-December 2005 | Go to article overview

Trade Openness and Economic Growth: Search for a Causal Relationship


Hassan, A. F. M. Kamrul, South Asian Journal of Management


This paper examines whether openness to international trade plays any role in reducing poverty in Bangladesh through its impact on economic growth. First, the paper examines the causal relationship between trade openness and economic growth and then examines the structure of international trade to see whether it is conducive to generate employment and income sufficient to reduce poverty in Bangladesh. Granger-causality test is employed to ascertain the direction of causality between trade openness and economic growth. The paper finds that there is long-run equilibrium relationship between trade openness and economic growth and there is unidirectional causality from trade openness to economic growth. But the structure of trade was not such that helps reducing poverty in Bangladesh.

I. INTRODUCTION

International trade is thought to be an important ingredient of economic growth, which is reflected in rapid globalization during the last couple of decades. The crux of the argument in favor of globalization is that openness to international trade accelerates growth and development. In the literature of international economics it is argued that trade openness leads to economic growth by increasing a country's specialization and productivity level. International trade is even better for small countries that do not have large internal market and a diverse and abundance resource base, because they can produce efficiently only by specializing in a very few goods which is not possible without trading with other countries (Lee 2004). This positive relationship between trade and growth has been evidenced in many empirical research works (for example Baldwin 1963; Keesing 1974; Krueger 1980; Meier 1984; Frankel and Romer 1999; Gallup, Radelet and Warner 1999 and Irwin and Tervio 2002). Being motivated by this argument that more trade stimulates economic growth, developing countries started undertaking reforms in their trade policy regime in the form of reducing tariff and non-tariff barriers to boost their international trade since the eighties, which is frequently dubbed as 'trade liberalization'. For poor countries trade liberalization and the resultant increase in the trade openness is thought to be an instrument of reducing poverty through its poverty-reducing impact on growth.

Trade-poverty relationship is both direct and indirect. Trade affects directly through its impact on cost of living, employment and wages. Trade also increases government revenue that can be spent on welfare activities like health and education. The indirect link between trade and poverty takes place through development and utilization of productive capacities, such as accumulation of physical, human and organizational capital, structural transformation and technological progress (UNCTAD, 2004). Thus, the indirect channel through which trade-poverty relationship is realized is economic growth. Trade accelerates growth and growth increases income and reduces poverty. This indirect trade-poverty link is most important for sustained poverty reduction in most developing countries in the long run. In other words, for sustained poverty reduction in poor countries through trade, there should be a long run equilibrium relationship between trade and economic growth.

Bangladesh is one of the poorest countries in the world. Over the last decade Bangladesh has made little progress in reducing poverty. Population below national poverty line has been decreased from 51.00% in 1995-96 to 49.80% in 2000. Compared with the magnitude of poverty this progress is insignificant. As per international poverty line, 36% of its population still lives on $l/day or less and nearly half of its population lives below national poverty line. Moreover, share of the poorest quintile in the national income decreased from 9.5% in 1988-89 to 9.00 in 2000 (see Table 1). Bangladesh is one of the countries that have failed to make reasonable progress in achieving target to reduce hunger (one of the dimensions of poverty) within 2015 as one of the Millennium Development Goals (MDGs) (UNCDAT, 2004). …

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