The Impact of Trade on Economic Growth - Essay Example

Trade and Economic Growth of the of the Purpose of Research The impact of trade on economic growth has been widely debated in economic literature. The gains from free trade have been widely discussed by economists like, Adam Smith and David Ricardo. Their theories had clearly proved that free trade between nations always augments degree of welfare between them. However, experiences of numerous countries in the present decade have shown that these theories are not necessarily true. This has led to a divide among the researchers as one group thinks that international trade has caused positive economic development of a large number of developing nations, while the other group is of the view that trade had adversely affected economic growth of developing nations in particular. Over past few decades, extensive work has been done in this field by employing various statistical models and has been criticized on grounds of assumptions and validity. Therefore, purpose of this paper is to investigate the positive developments to economic growth arising from trade and the reasons for which these gains are often not realized. This paper first analyzes positive impacts to economic growth that could be directly attributed to trade. Then, the paper studies empirical evidence from a host of nations in order to verify whether or not these advantages are effectively realized. The aim is to see whether trade always accrues benefits for nations, thereby contributing to their economic growth. Analysis The existing literature points out that there a large number of benefits that can be derived from trade. Researchers have also differentiated between static and dynamic impacts, which could be achieved from trade between nations. Static gains are related to improvement in social welfare with fixed amount of input and dynamic gains from trade refer to change in the production structure due to adoption of new technology (Didier & Pinat, 2013). Firstly, trade helps in alleviation of poverty by increasing opportunities for commercial investments. It also helps in development of the private sector by boosting their sales from increased demand. Secondly, trade helps in enhancing competitiveness of developing countries by reducing the cost of inputs and adding value to their products. Rising trade brings in more investments for countries, which in turn improves infrastructure and quality of lives of individuals. Thirdly, trade has also been identified as a major vehicle for export diversification that can be achieved by developing countries. This enhances possibility of the developing countries to access new markets and materials, thereby improving their production possibilities. Fourthly, trade between nations also helps in innovation as it becomes a medium of exchange for technological know-how. Trade also improves the investment in technology and research by attracting FDI. Fifthly, trade is not only beneficial from point of view of the manufacturer, but also from that of consumers. This is because of the fact that trade increases the number of options for buyers by way of presenting more products as choices. As a result, inferior and high priced goods are eliminated from the market and superior goods are available to consumers. Sixthly, trade also helps in improving quality of labor and environmental standards. This is because when two trading partners are involved in a business relationship, they can learn from one another about the best practices involved. Finally, it can be said that trade enhances employment opportunities for the people. Trading between nations can create stable jobs in various sectors like, manufacturing and service, which in turn improves livelihood of people involved in these jobs (European Commission, 2012). Figure 1: Growth of developing countries and trade (Source: Nehru, 2011) The above graph plots the rate of economic growth for developing countries. It can be clearly seen from the graph that there is an overall trend of growth in rate of income for all countries in general. The rate of growth has been highest for Southeast Asian countries, which are closely followed by Latin American countries. However, South Asian countries could not match up with success of South East Asian countries. One of the major reasons that have been attributed behind outstanding growth performance of these countries is increased dependence on trade. It has been observed that particularly for the South East Asian countries, strong economic growth could be directly correlated to heavy dependence on trade. The trade-to-GDP ratio for these countries is in excess of 150% (Nehru, 2011). Research work conducted by a number of researchers has shown that the positive impact of trade on income has been experienced by a number of OECD countries. The rise in individual incomes of people contributes towards economic growth of the nation as a whole. This is because an increase in income of the laborers of a country is associated with the same in per-capita income, which can be taken as an indicator for overall economic growth of a nation. It has been observed in case of African countries that 1% increase in the trade to GDP of the country is associated with 0.5% growth of African nations in short run and about 0.8% growth in the long run (Bitzer & Geishecker, 2006). The research conducted by Parikh & Stirbu (2004) had provided a useful insight about the relation between trade liberalization and economic growth of a nation. Their research had a broad sample of 42 developing countries and a time frame of three decades. The results obtained had indicated that there is a positive correlation between trade liberalization, economic growth and investment growth. Few exceptions were observed in the results, but on a general basis, it could be concluded that trade had positively contributed towards economic growth. Finally, experience of China can also be treated as an example of positive relation between trade and economic growth. Since the joining of China in the WTO in 2001, the country has enjoyed robust growth rates (Parikh & Stirbu, 2004). Figure 2: Relationship between GDP growth rate and trade (Source: Parikh & Stirbu, 2004) The above graph shows the correlation between GDP, current account and trading account for the countries chosen in the research of Parikh & Stirbu. It can be seen that trade can be positively associated with economic growth. Figure 3: Selected countries and growth in imports and exports (Source: Parikh & Stirbu, 2004) This table above shows growth in imports and exports of countries on account of rise in trade activities. It can be clearly seen from the figures that there has been surge in both imports and exports of nations. As these form basic components in the GDP calculation, it could be correlated with higher economic growth of nations. Figure 4: Trade helped to reduce the severity of recession by fuelling growth (Source: World Trade Organization, 2011) In a more recent research that has been conducted by WTO, it is indicated that trade has been able to reduce the adverse impacts of recession during 2008. The above figure clearly shows a strong and direct relationship between GDP growth and trade. The positive growth of GDP with rise in the volume of imports and exports is an evidence of this fact. Figure 5: Association of export growth and GDP (Source: World Trade Organization, 2011) The above chart plots the association between merchandise exports and GDP over the last decade. The figure clearly indicates that association between the two is fairly positive. Researchers had argued the basic reason behind rise in growth rate is the capital accumulation. The other sources of strength that has been identified as positive factors, contributing to economic growth of a nation, are improvement of the industrial structure, in institutional factors and in technology. If a country engages in importing capital goods that it cannot produce independently, then this improves the level of productivity, which in turn promotes country’s economic growth (Lee, 1995). Based on these theoretical framework and empirical evidences, it can be concluded that trade has a positive impact on economic growth of the nations. In the recent times, a few researchers have even focused on the causes of economic growth that arises from trade. It has been observed that most of the positive contributions made towards economic growth come from technology diffusion and knowledge transfers. In fact, extent of economic growth resulting from trade is dependent on factor accumulation and rise in productivity that comes from trading. The positive spillover of trade on level of economic growth is observed to be more when trading between nations takes place for similar industries. Export demand has been found to be one of the most important determinants of the positive spillover. This is because increase in export demand of a country boosts the export industries and employment associated with it. Import, on the other hand, improves knowledge and productivity of a country, especially when the import pertains to goods that involve high-end technology. The extent of positive growth in nations is also high, if the trade has higher human capital intensity involvement (Frankel & Romer, 1999). However, there are a number of other research works and evidences, which suggest that trade between different nations leads to marginalization of particularly poorer nations. In other instances, it has been found that the trading partners do not comply with the universal ideology of “free trade” and often promote restricted trade practices. The chief reason behind following this protectionist trade policy is that nations want to protect their infant industry in their nascent stage. This is done to increase exports of some selected products and reduce the imports of others. In most cases, protectionist trade policies are promoted by the government in order to ensure that income and employment generation of the protected sector can be improved. These practices are followed by developing and developed countries alike. For instance, it has been observed that the U.S.A. follows protectionist policies in industries like, cotton, timber and sugar beets. This is done to safeguard these industries from aggressive foreign competitors who can produce similar products at a lower cost. These are done through instruments like, tariffs, quotas and subsidies, which are provided by the government. The implication of such a practice is improvement of the country’s domestic level of production, thereby contributing to higher growth, but that of the trading partner is marginalized. This policy has been termed as “beggar thy neighbor” (Howard, 2011). In the recent years, it has been found that trade between U.S.A. and China had increased trade deficit for the latter. This can severely impact growth of U.S.A. in the long run. This is because growing trade deficit of the U.S.A. has already resulted in loss of large number of jobs in manufacturing and stagnation of real wages for common people. This implies that restrictive trade practices of China (a developing nation) can also negatively affect growth of the U.S.A. (a developed nation). Most of the researches indicate that World Trade Organization, which was set up in 1995, has a major role to play in the uneven distribution of gains from trade. The last decade had witnessed a large number of small and developing nations joining WTO in order to obtain the benefits of trade. A close analysis of these countries revealed that they have often been marginalized because their interests are imperfectly aligned with that of the whole system. The main reason that has been cited for this is that poor countries have small markets, which are financially weaker than other countries. As a result, they are not being able to function properly based on the reciprocity principle, which is at the core of WTO functioning. Guatemala is another country, which has been subjected to unfair trade practices of the European Union. There was a strong belief that practices followed by European Trade Union in 2006 was highly detrimental for positive economic growth of Guatemala as all benefits was particularly enjoyed by countries of the European Union. The trade policies required that Guatemala should open its markets unconditionally to the European market so that the latter can easily obtain raw materials. Guatemala, on the other hand, complained that Europe was simply draining raw materials from them without facilitating any positive growth (World Development Movement, 2014). Conclusion This paper has focused on the relationship between trade and economic growth between nations. It must be recognized that this relationship is ambiguous to an extent and there is considerable debate among researchers regarding the exact nature of relationship. Based on the analysis conducted in this paper, it can be said that there seems to be a positive relationship between economic growth and trade among nations. Most of the developing countries like, Asia and Latin America, had widely gained from trade liberalization measures. This has been strongly related to the rise of trade volumes in these nations. Similarly, most countries that had engaged in trading practices have shown an increase in their level of economic growth. Even so, some evidences suggest that free trade between nations do not always yield benefits for both the nations and may harm growth. It has been observed that especially for weaker countries of the African continent, there has been considerable marginalization associated with trading activities. The unemployment and poverty rates in African nations have worsened on account of unfair trade practices, which are followed by European and American countries for their own benefits. From these facts, it is concluded that trade can positively contribute towards economic development only when both the trading partners are equally benefitted. Otherwise, it might lead to a situation, where one country is benefitted and the other faces potential decline. References Bitzer, J. & Geishecker, I. (2006). What drives trade-related R&D spillovers? Decomposing knowledge-diffusing trade flows. Economics Letters, 93(1), 52-57. Didier, T. & Pinat, M. (2013). How Does Trade Cause Growth? World Bank. Retrieved from https://www.gtap.agecon.purdue.edu/resources/download/6158.pdf. European Commission. (2012). 10 Benefits of trade for developing countries. Europa. Retrieved from http://trade.ec.europa.eu/doclib/docs/2012/january/tradoc_148991.pdf. Frankel, J. A. & Romer, D. (1999). Does Trade Cause Growth? The American Economic. Howard, F., 2011. Free-trade agreements. Retrieved from http://www.ilo.org/oshenc/part-iii/development-technology-and-trade/item/343-free-trade-agreements. america ex Lee, J. W. (1995), Capital goods import and long-run growth, Development Economics, 48(1), 91-110. Nehru, V. (2011). 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