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Summary of WP/92/90

Author(s):
International Monetary Fund
Published Date:
January 1993
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Summary of WP/92/90

“International Trade, Distortions and Long-Run Economic Growth” by Jong-Wha Lee

How are international trade and trade policy linked to long-run growth? How much can differences in trade policy explain cross-country variations in long-run growth rates? This paper attempts to present new insights into these long-standing questions.

The paper investigates the links between trade and growth in a neoclassical model of an open economy in which domestic production requires both domestic and imported inputs. The model shows that trade distortions induced by such government policies as tariffs and exchange controls generate significant cross-country divergences in growth rates and in per capita income over a long transitional period. An interesting theoretical prediction is that the effects of trade distortions on the growth rate of a country depend on “free trade openness”--the country’s share of imports in GDP under a free trade regime. Thus, distortionary trade policies are considered to be more disadvantageous to growth in small, resource-scarce countries, which would be more open in a free trade regime, than in large, resource-abundant countries. The model also explains why capital may flow from low-income to high-income countries: namely, because trade distortions decrease substantially the marginal productivity of capital, they may cause capital to flow from highly distorted low-income countries to high-income countries with low distortions.

The paper presents empirical findings on the links between trade distortions and economic growth by using a cross-section of data on 81 countries from 1960 to 1985. The empirical results confirm that tariff rates on imports of foreign inputs and black market premiums, interacting with an estimate of “free trade openness,” have significant negative effects on the growth rate of per capita income. In a typical developing country, whose import share would be 20 percent of GDP in the absence of trade distortions, distortionary trade policies, such as a 25 percent tariff and a 50 percent black market premium, decrease the growth rate by about 1.4 percent a year.

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