TRADE AS AN ENGINE OF ECONOMIC GROWTH

 

TRADE AS AN ENGINE OF ECONOMIC GROWTH

Economic growth is obviously a very important subject of economics. To understand the causes of economic growth must be of greatest importance since it can help to design institutions and policies so that the resources available are used efficiently. Growth is definitely not without cost as it requires giving up consumption today for consumption in the future.

Trade is commonly regarded as an engine of economic growth. It is true if the markets work well. Markets are always embedded in an institutional environment which includes laws, regulations, policies, beliefs, organizations and other institutions that affect the behaviour of economic agents. Both trade and a well designed institutional infrastructure are necessary to achieve the desired rate of growth with efficient use of resources.

Trade allows a more efficient use of resources through specialization according to comparative advantage. Such specialization raises the level of GDP.

Secondly, trade means access to a greatly extended market and thereby makes possible to take greater advantage of increasing returns to scale in production.

Thirdly, trade exposes producers to international competition, forcing them to reduce prices.

Fourthly, trade gives consumers and producers access to a wider variety of goods. Greater choice is a clear gain for consumers and can increase productivity for producers by providing them with more specialised and more appropriate inputs.

A country that reduces trade barriers can expect to reap the gains over a relatively long period of time. Essentially static gains from trade will then be registered as an increase in the rate of growth.

Trade can raise productivity growth by making a substantial difference in R & D [Research and Development] spending. It is noticed that although Germany has spent more than double in resources on R & D relative to GDP than Italy during two decades, their growth rates had been similar. This can be explained by free information flows and free trade. These have allowed Italy to take advantage of learning and innovation that has taken place in Germany or elsewhere.

In a world economy where learning and innovation are freely available to all in all countries, it would not matter where learning and innovation takes place. Every country would benefit to the same degree and per capita growth rates would benefit to the same degree and per capita growth rates would tend to converge to the same rate. However, learning and innovation are not costless even if they are freely available. Some learning is hard to transfer from brain to brain and many innovations are protected by patents. Moreover, even if information and innovations are freely available, to find, transfer and implement relevant knowledge is costly.

Another way in which trade promotes growth is by providing a large market and thereby greater incentives for spending resources on innovations. A large market potentially means greater profits. This is specially true for small countries whose markets are smaller. The creation of a world market through trade tends to increase spending on research and development. Without trade and international competition we wouldn’t have probably visualized so much innovations and R & D.

We can find empirical evidence for positive effects of trade. We can observe many countries, both in the past and in the present which had very high growth rates, at the same time they had open and export oriented trade regimes. Is it not self evident that, for example, Hong Kong or Singapore has achieved their economic success due to trade?

One needs to be a bit careful when assuming, first that there must be a clear and positive relation between degree of openness and the rates of growth and second that trade causes growth.

First, the degree of openness of an economy depends on its resource endowments, technologies, preferences and market structure. If consumers in some countries have preferences that are very biased towards domestic goods and services, that country will be less open.  A country where consumers are biased towards foreign goods and services will be more open.

Second, the direction of causality between trade and growth is not certain. Growth may cause trade or trade may cause growth or both may be caused by some other exogenous factor.

There is a considerable agreement among researchers that free trade by itself is not sufficient to generate high rates of growth.  Well functioning markets are also required. For markets to work well, they have to be supported by a favourable institutional environment- a set of laws, rules, organisations and policies that define, protect and enforce property rights so that individuals and firms are encouraged to undertake investment in physical and human capital in research and development.

So, we can conclude that foreign trade is definitely helpful for economic growth.