Georg-August-Universität Göttingen (founded in 1737) Diskussionsbeiträge Documentos de Trabajo Discussion Papers. Nr. 147

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1 Ibero-Amerika Institut für Wirtshaftsforshung Instituto Ibero-Ameriano de Investigaiones Eonómias Ibero-Ameria Institute for Eonomi Researh (IAI) Georg-August-Universität Göttingen (founded in 1737) Diskussionsbeiträge Doumentos de Trabajo Disussion Papers Nr. 147 Relating Produtivity and Trade : A Chiken and Egg Analysis Eleanor Doyle, Inmaulada Martínez-Zarzoso June 2006 Platz der Göttinger Sieben Goettingen Germany Phone: +49-(0) Fax: +49-(0) uwia@gwdg.de

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3 Relating Produtivity and Trade : A Chiken and Egg Analysis Eleanor Doyle, Department of Eonomis, University College Cork, Ireland, and Inmaulada Martínez-Zarzoso, Ibero Amerika Institut for Eonomi Researh, Universitaet-Goettingen, Germany and Department of Eonomis, Universitat Jaume I, Castellon, Spain. Abstrat Given the nature and range of investigations of the trade/produtivity relationship, we now know that possible reverse ausation must be a onsideration in empirial researh. Indeed, some researh finds that estimates of produtivity gains attributed to trade apture instead the roles of institutions and geography. Here we estimate the relationship between produtivity and trade for a panel of ountries over the period 1980 to 2000 using instrumental-variables estimation of a produtivity equation. The endogeneity of trade and institutional quality is aounted for by using instruments. We extend the speifiation used by Frankel and Romer (1999) using real openness as the measure of trade (following Alala and Cione, 2004). The trade instrument is based on a gravity equation. The instruments for institutional quality ome from Gwartney, Holombe and Lawson (2004). This approah allows for identifiation of hannels through whih trade and prodution sale affet produtivity. DRAFT: PLEASE DO NOT CITE OR CIRCULATE WITHOUT AUTHORS PERMISSION.

4 I Introdution Interest in the relationship between trade (or openness) and growth is evident aross an extensive range of eonomi researh. Empirial evidene points to a relationship between trade and inome growth via produtivity. Just how to aurately onstrut and examine this ausal relationship is problemati, however, as indiated by an array of theoretial investigation of this link. Developments in applied eonometris have allowed for various approahes to be used to investigate how trade and produtivity are related but more reent researh has foussed on whether estimated links between trade and produtivity apture the roles of institutions and geography. The measurement of trade in this literature inludes expliit examination of exports only and their relationship with output and/or produtivity. Some researh inludes openness as the measure of trade taking into aount both exports and imports as separate but related hannels that drive output or produtivity growth. The standard measure of openness is a nominal measure of the sum of exports and imports expressed as a fration of nominal GDP. However, this measure reates diffiulties as outlined in Alala and Cione (2004) due to the potential outome of Balassa- Samuelson effets, whih they presented for ross-ountry analysis using 1985 data. Motivated by the substantial literature in this area, this paper investigates the effet of international trade on produtivity aross a sample of 73 ountries over the period 1980 to Alternative measures of openness are used to ompare the impliations of using real or nominal openness. To take aount of the potential endogeneity of trade and institutional quality we use instruments. The seleted instrument for trade follows the standards of Frankel and Romer (1999), whih argues that trade is determined partially by ountry fators unrelated to produtivity. Following the work of Hall and Jones (1999) and Aemoglu, Johnson and Robinson (2001) the hoie of instruments for institutional quality rest on the relationship between historial European influene and diffusion of the European institutional struture. The paper is strutured as follows. Setion II provides the bakground literature on the trade-growth relationship and identifies the problems assoiated with measures of openness in empirial work. In Setion III the seleted produtivity 2

5 equation we estimate is presented and disussion of the instruments is provided in detail. Analysis and findings based on our estimated results is provided in Setion IV while onlusions are offered in Setion V. II Trade, Produtivity and Openness Open eonomies an benefit from speialisation, whih allows for the generation of higher levels of inome from a omparative advantage perspetive. This means that when more of a ountry s available resoures are devoted to produing goods in whih it has effiienies (measured as lower opportunity osts of prodution) relative to other ountries and it an import the goods in whih it is less effiient, overall national output and onsumption rise. Through reating international demand for domesti resoures that might otherwise remain unused, a further (demand-side) basis for making more effiient use of resoures exists in relation to trade. Stati effets of speialisation hange the eonomy s prodution (and labour) mix inline with omparative advantage and this in line with ability to trade at international pries leaves onsumers better off. If dynami benefits are also possible then as the market expands, the potential for greater division of labour arises, and the skills of labour may rise in response to greater division of labour. Hene, produtivity improvements are observed in an outward expansion of the prodution possibilities frontier (Myint, 1958). As ountries open up to trade, international ommuniation of ideas and tehnology also beomes inreasingly possible and may have the effet of intensifying ompetition in both import and export markets, inreasing the inentive for both imitation and innovation and aelerating the rate of tehnial progress that an lead to effiieny gains through more ompetitive ost strutures and produtivity improvement. Foreign exhange onstraints may be eased also sine inreased exports provide a soure of foreign exhange for ountries that wish to purhase imports of final produts or inputs that embody domestially unavailable tehnology. In a senario where inreased exports lead to ost redutions and inreased effiieny the underlying ausal diretion is from trade (partiularly export growth) to output growth. Suh ases desribe export-led-growth, whih is theoretially assoiated with the view of trade as an engine of growth. The extent to whih positive externalities are generated from involvement in international markets, through 3

6 resoure alloation, eonomies of sale and pressure on new training for example, underpin how the hypothesis operates in pratie (Medina-Smith, 2001). An alternative ausal explanation is manifest in Verdoorn's law whih holds that output growth has a positive impat on produtivity growth. Kaldor (1967) attributed this relationship to fators inluding eonomies of sale, learning urve effets, inreased division of labour, and the reation of new proesses and subsidiary industries. In this ase produtivity growth in the industrial setor, in partiular, is onsidered as the prinipal determinant of output growth. Improved produtivity and redutions in unit osts due to inreasing returns simply make it easier to sell abroad (Kaldor, 1967: 42) implying a ausal relationship from output growth, via produtivity growth, to export growth. Many studies onfirm a statistial relationship between export growth and output growth (Mihaely, 1977; Krueger, 1978; Balassa, 1978; and Feder, 1982). The potential benefits of export growth for eonomi development have been widely disussed (e.g. Keesing, 1967; Krueger, 1980; Bhagwati, 1988a; Greenaway and Sapsford, 1994) and empirially tested for many less developed ountries, (Balassa, 1978; Feder, 1982; Bahmani-Oskooee and Alse, 1993). However, for more industrialized or developed eonomies the potential benefits of export growth may be less important beause positive externalities enjoyed by LDCs are signifiantly higher than for developed ountries, whose infrastrutural development is more advaned (Afxentiou and Serletis, 1991). Benefits from inreased ompetition are lessened sine advaned ountries are more ompetitive and new tehnology will have less impat beause to retain ompetitiveness, ontinuous improvements in tehnology are required. The export-growth orrelation appeared to be partiularly pronouned in the ase of industrialized ountries and Mihaely (1977) and Tyler (1981) onsidered a minimum level of development was required for a signifiant relationship to be observed between output growth and export growth. However, the empirial approah based on ross-ountry orrelations between exports and output (or produtivity) yields no information for the ausality question as they deal with statistial and not ausal relationships. Many further studies have found a moderate positive relationship (Frankel and Romer, 1999: 379) between trade and inome inluding Feder (1983), Kormendi and Maguire (1985), Fisher (1991, 1993), Dollar 4

7 (1992), Levine and Renelt (1992), Edwards (1993) and Harrison (1996). Unfortunately, as outlined further below, the potential endogeneity of the trade share has impliations for the onfidene that an be plaed in the estimates. Studies using Granger or Sims proedures to investigate ausality do not provide onlusive support for the export-growth relationship (Chow, 1987; Jung and Marshall, 1985). 1 The existene of non-stationarity in the time series onsidered an lead to spurious regression results and invalidate the onlusions reahed using Granger tests of ausality, asting doubt on the results of the ausality researh arried out when the stationarity properties of the data were not identified. It is only possible to infer a ausal long-run relationship between non-stationary time series when the variables onerned are ointegrated (Engle and Granger, 1987). 2 If ointegration analysis is omitted, ausality tests present evidene of simultaneous orrelations rather than ausal relations between variables (Granger, 1988). As Ram (1985) points out it is important to be able to make a reasonably satisfatory transition from statements about the orrelation patterns to some judgements about the ausal struture (p. 416). Cointegration studies also yield differing results on the trade-growth relationship for ross-ountry analyses over differing time periods (Axfentiou and Serletis, 1991; Marin, 1992; Oxley, 1993; Bahmani-Oskooee and Alse, 1993). Omitted variables not ontrolled for will also have impats on output and exports, and hene, measured ausal impats are inaurate (Kwan and Kwok, 1995). Variables suh as the terms of trade and apital stok have been inluded in export-growth analysis (Ghartey, 1993; Henriques and Sadorsky, 1996; Jin and Yu, 1996). Advanes in eonometri tehniques for ausality analysis (Toda and Yamamoto, 1995; Zapata and Rambaldi, 1997) were based on the observation that the F-test proedure used for ausality tests was not valid (i.e. it does not have a standard distribution) if time series are I(1) first differene stationary, a feature shared by a 1 Chow (1987) examined manufaturing industries and found bi-diretional ausality for Hong Kong, Israel, Singapore, Taiwan and Brazil, uni-diretional ausality from export to output growth for Mexio and no ausality for Argentina. Jung and Marshall (1985) used Granger ausality tests and found support for the export-led growth hypothesis for just four out of thirty-seven developing ountries. A statistially signifiant relationship from output growth to export growth was found for three ountries. Six ountries exhibited evidene of an export-reduing growth relationship, while a further three supported a growth-reduing exports relationship. Darrat (1986) and Hsiao (1987) find a similar lak of support for the export-led growth hypothesis. 2 Granger tests of short-run ausality an still be undertaken when series are not ointegrated. 5

8 large proportion of maroeonomi variables. Using augmented prodution funtion methodology in a VAR framework and taking this finding into aount, Shan and Tian (1998) found that for Shanghai internal fators of foreign diret investment, labour, and investment ontributed to rapid output growth and that output growth ontributed to export growth over the period 1990 to In the ase of China from , Shan and Sun (1998) found a feedbak effet indiating bidiretional ausality between exports and real industrial output (a proxy measure of output). Using a similar framework, Doyle (2001) found bi-diretional ausality for Ireland ( ) and the terms of trade and foreign demand displayed statistial signifiane in explaining ausality. Bidiretional ausality is a possibility when produtivity inreases that are made through the exploitation of sale eonomies lead to inreased exports (Kunst and Marin, 1989). This ours if the market struture hanges (brought about by inreased trade) result in fewer firms and if sale eonomies allow for inreased ompetitiveness through further ost redutions. Hene a potential feedbak effet exists between export growth and output (Sharma et al, 1991). Bhagwati (1988b) also onsidered the possibility for two-way ausation between growth and exports (or trade in general) arguing that inreased trade, regardless of its ause, stimulated inreased output and in turn additional inome failitated more trade, generating a proess of a virtuous irle of growth and trade. In terms of new trade theory, Romer (1990), Grossman and Helpman (1991) and Rivera-Batiz and Romer (1991) developed models where an expansion of international trade inreases growth by inreasing the number of speialized prodution inputs. In models of imperfet ompetition and inreasing returns to sale, however, this outome is ambiguous (Helpman and Krugman, 1985) and Grossman and Helpman (1991) also pointed out that tariffs ould be growth reduing. The impat of trade on growth appears to depend on market ompetition, market ontestability and whether the market struture is stable with regard to trade disturbanes or will be altered and lead to produtivity improvements and tehnial effiieny. Marin (1992) inluded models of imperfet ompetition in his analysis of the exports-output relationship and posited that exports lead to output growth (through produtivity enhanement) the smaller the ountry and the less entry that ours. He based this view on the fat that minimum effiient sale of prodution is large relative 6

9 to the home market so that the potential of exploitation of sale eonomies through export expansion was high. An export expansion is more likely to lead to produtivity improvements if the entry of new firms instigates greater ompetition foring ineffiient firms to exit and inreasing the inentive for inumbents to invest in R&D. Reent examinations of trade and growth examine the extent to whih produtivity hanges attributed to trade instead measure the effets of institutions and geography, rather than trade. The inlusion of variables to ontrol for geography and institutional quality rendered trade insignifiant in a number of studies (Rodrik, 2000; Rodriquez and Rodrik, 2001; Irwin and Tervio, 2002). Frankel and Romer (1999) outline the diffiulty in trying to find if trade auses growth sine if the trade share (or openness) is endogenous, ountries with high inomes due to reasons other than trade, may trade more. Sine geography is a strong determinant of trade gravity models (Linneman, 1966; Frankel, 1997) are indiative - and geographial harateristis are not affeted by inome, it an be used as an instrument for trade. In this ontext, Alala and Cione (2004) identify potential defiienies in using the standard measure of openness (nominal exports plus imports expressed relative to nominal GDP) for the trade share and estimate a measure of real openness used in a ross-ountry analysis of the trade-produtivity relationship using 1985 data. Trade is found to be a signifiant and robust determinant of aggregate produtivity. Our study follows the approah adopted but extends it in a time-series ontext from 1980 to 2000 aross a sample of 73 ountries. 3 Basis of Empirial Approah The essene of Alala and Cione (2004) is that the trade-related Balassa- Samuelson (Balassa 1964; Samuelson, 1964) hypothesis implies that using nominal openness as a measure of trade is problemati. If trade inreases produtivity, where gains are greater in manufaturing than in non-tradable servies, a rise in the relative prie of servies might result in a derease in openness. This is shown in a trade model with gains from speialisation, whih is defined as the prodution of fewer varieties of tradable goods but in larger quantities. From the model, GDP in ountry equals aggregate onsumption (assuming balaned trade) where GDP = d y + a (1-t)x = tx + a (1-t)x 7

10 d y a (1-t) t x measures the number of varieties of tradable goods produed in ountry (as this measure of tradable goods produed domestially falls, the ountry beomes more speialized); denotes prodution of eah tradable good reflets the equilibrium prie of non-tradable goods in ountry (refleting fator effiieny in tradable goods setors relative to non-tradable goods setors). It is assumed that a = g (d, L ) where L denotes households supply of labour. It is further assumed that households want to onsume the same quantity of eah tradable and non-tradable good irrespetive of the prie of non-tradables. denotes the fration of ommodities that are non-tradable denotes the fration of tradable goods produed in ountry denotes onsumption of eah good. The prodution funtion in tradable goods is onstant returns to sale where y = A l where A is ountry-speifi fator effiieny and l denotes labour. In turn, it is given by A = B g (d, l ) where B is an exogenous parameter, and l is aggregate employment. Gains from speialisation our assuming δg/δd < 0. Inreasing returns to aggregate employment our assuming δg/δl > 0. Gains from speialisation are limited to this setor and no inreasing returns are possible in non-tradable goods whih are produed aording to the prodution funtion s = B l. Assuming balaned trade and labour market learing, Alala and Cione (2004) show that the share of labour alloated to non-tradable goods prodution is (1-t)a / t + (1-t)a. Given this and the prodution funtions and the equation for a, PPP GDP is shown to depend on speialisation. PPP GDP L = 1 g( d, L ) t + a( 1 t ) B t + ( 1 t ) where average labour produtivity in PPP inreases in the degree of speialisation and in aggregate employment. In equilibrium nominal openness is Open Im ports = 2 GDP t d = 2 t + ( 1 t ) a 8

11 An inrease in speialization an affet openness in two ways. A higher degree of speialisation, for a given prie of non-tradable goods, raises openness as it implies a larger volume of imports. Aording to the equation deriving a, a higher degree of speialisation raises the prie of non tradables, whih lowers openness. Hene, higher openness is not neessarily assoiated with higher PPP labour produtivity. Real openness is given by ROpen Im ports = 2 PPP GDP t d = t + ( 1+ t ) a whih implies that as the prie of non-tradables used to value prodution is the same aross ountries, real openness is a linear and inreasing funtion of the degree of speialisation and average labour produtivity in PPP an be written as an inreasing funtion of real openness Estimating Equation and Data We extend Frankel and Romer s (1999) speifiation to onsider the relationship between produtivity and trade, following Alala and Cione (2004). PPP GDP log Workfore = x 0 + x1trade + x2 log DSale + x3 log Area + x 4 IQual + a X + u where PPPGDP denotes Produtivity Per Worker. Trade represents measures of openness (both nominal and real are onsidered here where real openness is national imports plus exports (in US $) divided by national GDP in PPP US$ (instrumenting is disussed below). DSale represents domesti sale of prodution. This is inluded sine the size or sale of a ountry impats not only its propensity to trade externally, but also internally, as explained by Frankel and Romer (1999: 380). Hene, a seond geography-based test of trade s impat is onsidered by examining whether intraountry trade inreases inome fousing on whether larger ountries, measured by population or workfore, have higher produtivity. 4 3 Alala and Cione (2004) pointed out that although all gains from speialization are supposed to our in tradables, this assumption is not neessary for speialization to inrease the prie of nontradables. 4 Frankel and Romer (1999) fous on inome per person. In line with Alala and Cione (2004) our interest is in produtivity. 9

12 Data for produtivity, nominal imports and exports, GDP in PPP US$ used to measure openness, and population to measure sale are all taken from the Penn World Tables, 6.1 (Heston et al, 2002). For omparison purposes, labour produtivity data were also taken from the Groningen Growth and Development Centre (GGDC) Total eonomy Database. 5 A 78-ountry sample is onsidered for whih labour produtivity data are available from both soures. Data limitations require that a smaller sample than in Alala and Cione (2004) is employed. However, ountries in our sample have more reliable data and are larger in size; hene their produtivity is less likely determined by idiosynrati fators (Frankel and Romer 1999:387). Area represents the land area in square kilometres taken from the World Development Indiators (2005) of the World Bank. IQual denotes institutional quality. Sine we are onduting time-series analysis we require a measure for the period The Eonomi Freedom of the World Index (Gwartney and Lawson, 2003: Gwartney, Holombe and Lawson, 2004) 6 measures institutional quality aross five areas: size of government, legal struture and seurity of property rights, aess to sound money, exhange with foreigners and regulation of apital, labour and business. Data for 100 ountries are available for the time period we onsider. Should Iqual be endogenous, instruments are required. In instrumenting for institutional quality, Hall and Jones (1999) use the population share speaking English sine birth, the population share speaking one of the five primary European languages, distane from the equator and Frankel and Romer s (1999) geography based trade measure. 7 X represents geography ontrol variables inluding distane from the equator (measures used in Hall and Jones (1999) are used here) 8 and ontinent dummies for Europe, Afria, Ameria, Asia and the omitted dummy is represented by the interept. 5 The Conferene Board and Groningen Growth and Development Centre, Total Eonomy Database, May 2006, 6 The authors are extremely grateful to Jim Gwartney and Bob Lawson for making the data available at 7 Hall and Jones (1999) onsidered that the first three variables are orrelated with historial influene of Europe and with providing a hannel for the European institutional framework to have a growth impat. Alala and Cione (2004) drop the fration of English speaking population finding it does not support predition of the endogenous variables in the speifiations used. Aemoglu, Johnson and Robinson (2001) use European settler mortality during the 18 th and 19 th enturies as an instrument. 8 The authors are extremely grateful to Robert Hall for making the data available at 10

13 If trade and institutional quality are endogenous, OLS annot be used for the estimating equation. Two-stage least squares is appropriate. To develop the instrument for trade, Frankel and Romer s (1999) method is followed. A gravity equation is used to estimate bilateral trade shares using ountries geographi harateristis and size as explanatory variables. The data set used is a ross-setion of bilateral trade flows aross 178 ountries between 1980 and The data are from Rose (2005) 9 ; we provide limited details here sine data soures and desription an be found in the ited paper. In the speifiation of the bilateral trade equation the dependent variable is total trade in real terms relative to PPP GDP. We inlude log population and log area as measures of size, log distane as measure of transport osts and a number of dummy variables that proxy for ountries geographi harateristis and integration agreements. In addition, following Anderson and van Winoop (2003) we inlude exporter and importer ountry dummies as proxies for multilateral resistane terms. Anderson and van Winoop (2003) demonstrated that these terms have to be inluded in order to have a theoretially justified gravity-model speifiation. Thus, the equation we estimate is given by ln( Trade ijt ln Dist Currol gsp + / PPPGDP ijt µ ij ijt landl + 11 CU i ij ) = + α 6 i 12 + lang χ j ij Colony + φ + ij t Adj 1 13 ln pop ij + RTA 8 ijt it Island ij ln pop + 9 gw 1 + jt + Comol 15 3 gw 2 ij ln( A i A j ) The bilateral trade shares predited by the gravity equation are aggregated providing a geography-based instrument for trade for eah of the 73 ountries we inlude in the estimation of the produtivity equation (see Figure A1 in the appendix for a plot of the predited shares and real openness). 4 Desriptive Statistis and Estimation Results Table 1 ontains desriptive statistis and the orrelation matrix for seleted variables. Real openness displays a lower mean than openness. The orrelation between openness and real openness is high at Real openness is more highly 9 The authors are extremely grateful to Andrew K. Rose for making the data available at 11

14 orrelated with log average labour produtivity than openness (ompare 0.27 and 0.45 for the GGDC produtivity measure). The differenes are emphasised further when the logged trade measures are used (ompare 0.30 to 0.58). In line with Alala and Cione (2004) the differenes an be attributed to the Balassa-Samuelson effet (whih is further tested below). Table 1. Desriptive Statistis and Correlation Matrix Variable Obs Mean Min Max Std. Dev. lproa lpro open lopen ropen lropen lpop iqual lproa lpro open lopen ropen lropen lpop iqual lproa 1.00 lpro open lopen ropen lropen lpop iqual lpro lproa iqual englfra eurfra disteq lropen lopen lelrop2s lpro 1.00 lproa iqual englfra eurfra disteq lropen lopen lelrop2s Notes: lproa and lpro are the log of labour produtivity per worker from Penn World Tables and from the Groningen Growth and Development Centre respetively; open and ropen are openness and real openness, and lopen and lropen are the same variables in logs; lpop is the log of population and iqual is the institutional quality index. 12

15 4.1 Instruments Estimation Table 2 ontains the first-stage regression results for log real openness (lropen) and for our proxy of institutional quality (iqual). Table 2: First stage regressions Variables lropen Coef. t-ratio Coef. t-ratio Coef. t-ratio Coef. t-ratio Coef. t-ratio lelrop2s lpop lar disteq englfra dafria deurope dasia deastasia dsubsafria _ons R-squared Nobs F(10,47) iqual Coef. t-ratio Coef. t-ratio Coef. t-ratio Coef. t-ratio Coef. t-ratio lelrop2s lpop lar disteq englfra dafria deurope dasia deastasia dsubsafria _ons R-squared Nobs F(9,54) Our geography-based trade instrument is a statistially signifiant determinant of log real openness in the final two estimation periods of 1995 and 2000, when ontrolling for population, area, distane from equator, fration of population speaking English and the ontinental dummies. The F-statisti of the hypothesis that 13

16 our instrument an be exluded from the regression is statistially signifiant over all periods. Results of the first-stage regression for our proxy of institutional quality indiate that the distane variable is statistially signifiant in 2000 only. Neither population nor area is signifiant. The fration of population speaking English is statistially signifiant over all time periods. The fration of population speaking one of the main five languages in Europe was also initially inluded, but it was always insignifiant, therefore it is not inluded in the final regressions. Notably, the F- statisti is onsistently lower in these results when ompared to those for log real openness. 4.2 Trade and Produtivity We start by presenting ross-setion results for five seleted years in order to analyse the stability/evolution over time of the estimated oeffiients and to ompare our results with those obtained in previous researh. Table 3 reports our results using two-stage least squares (2SLS) estimation when examining the effet of trade on produtivity, where our dependent variable for labour produtivity is taken from the Penn World Tables. Our results show that in 1980, the variable area is signifiant at 5% level and only three of the ontinent dummies are statistially signifiant (1%) in explaining labour produtivity when ontrolling for population, area, distane from the equator, institutional quality and ontinent dummies. Results for 1985 are somewhat similar with distane to the equator indiating signifiane also. In 1990 only distane and the Australasia dummy are signifiant at 1% level, whereas institutions quality is signifiant at 5% level, in explaining produtivity. For 1995 and 2000, real openness and area display a statistially signifiant oeffiient (at 1% level). The 2000 results indiate that our measure of institutional quality, together with real openness, area and three of the ontinent dummies are determinants of labour produtivity. The results obtained in 2000 are more robust than those obtained in the previous years, the explanatory power is the highest and also the F-Statisti. The ontinent dummies indiate that one we have ontrolled for the trade, institutions and sale effets, labour produtivity is lower in the Afrian ontinent and 14

17 in Asia (exluding East Asia) than in North Ameria (default dummy). The evolution over time shows that in Sub-Saharan Afria the situation has worsened whereas in Europe and East Asia the negative differential has somewhat dereased and the dummy is no longer signifiant in the 1990s. Table 3. Instrumental Variables results (2SLS) 10 Variables: lpro Coef. t Coef. T Coef. t Coef. t Coef. t lropen iqual lpop lar ldisteq daustrasia dafria deurope deastasia dsubsafria _ons R-squared Nobs F(10,45) Wu-Hausman F test Durbin-Wu-Hausman Chi-sq test Sargan test (N*R-sq) Basmann test, Chisq(1) Notes: W-Hausman and Durbin-Wu-Hausman are tests of endogeneity of lropen and iqual (the results from the tests indiate aeptane of H0: Regressors are exogenous). Sargan N*R-sq and Basmann are tests of over-identifying restritions, a rejetion of the null hypothesis indiates that the instrumental variables estimator should be employed (results indiate aeptane of H0). As a next step, we present estimation results for the whole panel. Although we have seen in Table 3 that the absolute value and signifiane of the oeffiients varies for different years, we expet to find an average effet by running a single regression with time dummies for the five years under analysis. We onsidered both openness and real openness in estimation and used both PWT and GGDC measures of produtivity for omparison purposes. These results are shown in Table 4 for the omplete panel. 10 OLS results are provided (for both data soures of labour produtivity) in the appendix, for information. 15

18 Table 4. Comparing Openness with Real Openness (2SLS panel) Results with openness in nominal terms Results with real openness lpro Coef 1 t Coef 2 t Coef 1 t Coef 2 t Lopen/lropen iqual lpop lar ldisteq daustrasia dafria deurope deastasia dsubsafria y y y y _ons Adj. R-squared Nobs Wu-Hausman F test Durbin-Wu-Hausman Chi-sq test Sargan test (N*R-sq) Basmann test, Chi-sq(1) Notes: W-Hausman and Durbin-Wu-Hausman are tests of endogeneity of lropen (lopen) and iqual (the results from the tests indiate aeptane of H0: Regressors are exogenous). Sargan N*R-sq and Basmann are tests of overidentifying restritions, a rejetion of the null hypothesis indiates that the instrumental variables estimator should be employed (results indiate aeptane of H0). 1 The dependent variable is log of produtivity measured as GDP per person employed in 1990 GK $ from the Groningen Centre. 2 The dependent variable is log of produtivity measured as GDP per person employed in 1990 GK $ from the PWT. Institutional quality appears to explain produtivity aross when both openness and real openness are inluded in the speifiations and when either produtivity measure is employed. Distane from the equator is also statistially signifiant aross speifiations and produtivity measures. Real openness appears to be statistially signifiant only when GGDC produtivity data are used. Population is statistially insignifiant in all ases. Area is insignifiant when using openness for both produtivity measures but is signifiant when real openness is inluded in the speifiation. 16

19 For omparison purposes, we ran OLS regressions for eah year and using the two alternative measures for the produtivity variable. The results are shown in table A1 in the Appendix. The oeffiients are generally more preisely estimated under OLS than under 2SLS, sine the standard errors are almost always lower. We perform Wu-Hausman and Durbin-wu-Hausman tests of the hypothesis that trade and institutions quality are unorrelated with the residuals, and thus OLS are unbiased. For most of the oeffiients and years we annot rejet the hypothesis that the OLS and the 2SLS estimates are equal. The results from the tests are shown in the last rows of Tables 3 and 4.Both tests are, in the usual lassial statistial sense, being onservative about onluding endogeneity. If theory or evidene from other studies or even ommon sense suggests endogeneity, this may suffie to proeed with the 2SLS regardless of the results of the test. In this ase, it is onvenient to report both the OLS and the IV estimates and the test results, and interpret the findings from the analysis aordingly. In partiular, endogeneity is always rejeted when produtivity data from the Groningen entre are employed. Our results are in line with those found in Frankel and Romer (1999), sine they show that the IV and OLS estimates of the trade impat on inome never differ substantially. The authors find that moving from OLS to IV inrease the estimated impat of trade and ountry size on inome. On the ontrary, we find that examining the link between trade and produtivity using OLS overstates rather than understates the effet of trade. This is in aordane with the theory, sine ountries that are more open, are likely to adopt other poliies that enhane produtivity and are expeted to have better infrastrutures and transportation systems. For thoroughness, we also used 3SLS estimation to examine the trade- produtivity relationship aross our sample of ountries. This method provides a omprehensive and, arguably, more omplete estimation method aross the system of 17

20 equations that haraterise the relationships among our variables of interest. These results are presented in Table 5. By using 3SLS we also ontrol for the existene of ross-orrelation of the residuals in the three different equations. 3SLS ombines the seemingly unrelated regression (SUR) tehnique with the 2SLS tehnique and it is therefore more aurate. We observe that some of the oeffiients are higher in magnitude than those obtained with the 2SLS method (real openness and area) but the main results are unhanged: both real openness, institutions quality, area and distane and the ontinent dummies are statistially signifiant, whereas population is not. 18

21 Table 5. Panel results (Three-stage least-squares regression with time dummies) variables Coef. Std. Z variables Coef. Std. z Error Error lpro lropen lropen lelrop2s lpop lpop lar disteq iqual lar disteq eurfra dafria englfra deurope dafria daustrasia deurope deastasia daustrasia dsubsafria deastasia y dsubsafria y y y y y y _ons y _ons iqual lpop lar disteq eurfra englfra dafria deurope daustrasia deastasia dsubsafria y y y y _ons Equation Obs Parms RMSE R-sq lpro lropen iqual

22 One interesting aspet of our results is that in most of the regressions we find that population is insignifiant and negatively signed. Alala and Cione (2004) show in their regression results (Table 5:34) a positive and signifiant oeffiient for population, however, Table I (Alala and Cione, 2004: 30) shows a negative orrelation between population and real openness. In this table they do not show the orrelation oeffiient between area and population, it ould be that in their sample population and area are highly orrelated and the population variable is showing the effet of the area variable (the area variable is insignifiant in Alala and Cione, 2004). In our results, the area variable is positively signed and signifiant. A greater area an have a positive impat on produtivity via inreased natural resoures and a negative one via lower intra-ountry trade. Fousing on ountry size and holding population density onstant (population/area) the effet of ountry size on produtivity would be the sum of both the log of population and the log of area oeffiients (Frankel and Romer 1999). Only with this hypothesis are we able to find a positive sale effet in our results. We test for the Balassa-Samuelson Effet and results are provided in Table 6. We regress the prie level on real openness and other variables inluded in the produtivity equation. Both OLS and 2SLS estimations were onduted. All geography ontrols and a onstant were inluded. Results indiate that real openness has a highly signifiant positive effet on the prie level, onfirming the trade-related Balassa-Samuelson effet. 20

23 Table 6. Testing for the Balassa-Samuelson Effet (2SLS) Without Iqual With Iqual lprie Coef. t lprie Coef. t lropen lropen lpop iqual lar lpop ldisteq lar daustrasia ldisteq dafria daustrasia deurope dafria deastasia deurope dsubsafria deastasia y dsubsafria y y y y y y _ons y _ons Adj. R-squared 0.74 Adj. R-squared 0.72 Nobs 292 Nobs 292 Wu-Hausman F test 0.02 Wu-Hausman F test 0.46 Durbin-Wu-Hausman Durbin-Wu-Hausman 0.97 Chi-sq test 0.02 Chi-sq test Sargan test (N*R-sq) 3.71 Sargan test (N*R-sq) 3.53 Basmann test, Chi-sq(1) 3.55 Basmann test, Chi-sq(1) 3.34 Note: Lprie is the log of the prie level from the PWT. 4.3 Robustness We tested for the robustness of our results to inlusion of outliers. The results of our sensitivity analysis are provided in Table 7 (results for eah year (1980, 1985, 1990, 1995 and 2000) are not provided here but were similar). Statistial signifiane of real openness (lropen) appears robust, however, but not for the non-oecd ountries in our sample. Similar findings for institutional quality are evident. Population is insignifiant and area remains statistially signifiant over the entire set of analyses. Distane from the equator is not statistially signifiant for the OECD sample of ountries. 21

24 Table 7. Sensitivity analysis. Produtivity equation for different sub-samples Variables Benhmark Exluding HK, Lux., Sing. OECD NON- OECD lpro Coef. t Coef. t Coef. t Coef. t lropen iqual lpop lar ldisteq daustrasia dafria deurope deastasia dsubsafria y y y y _ons Adj. R-squared Nobs f(14,277) Wu-Hausman F test Durbin-Wu- Hausman Chi-sq test Sargan test (N*Rsq) Basmann test, Chisq(1) Notes: W-Hausman and Durbin-Wu-Hausman are tests of endogeneity of lropen (lopen) and iqual (the results from the tests indiate aeptane of H0: Regressors are exogenous). Sargan N*R-sq and Basmann are tests of overidentifying restritions, a rejetion of the null hypothesis indiates that the instrumental variables estimator should be employed. 5 Conlusions A onsiderable range of researh examines the role of trade in growth and produtivity. Some of this is disussed in Setion 2 of our paper, in partiular. Empirially, a range of results using different tehniques aross different ountry samples, yield alternative stories of how trade relates to produtivity and growth. We add to this literature using the real openness measure as a determinant of labour produtivity applied in a ross-ountry setting over the period. 22

25 Using the measure of real openness, we find that it is a statistially signifiant explanatory variable for labour produtivity aross our sample of ountries, when geography ontrols and institutional quality are inluded, for the data from 1995 and The effet is more modest than the previous literature suggested. The estimates suggest that a one-perentage-point inrease in real openness raises produtivity by only 0.55 per ent. Between 1980 and 1990, we find no statistially signifiant relationship between real openness and labour produtivity. This differs to the findings of Alala and Cione (2004) but different data soures and ountry sample were used and in partiular we used an alternative measure of institutional quality. (Interestingly, while their data refer to 1985, their institutional quality data were from 1997/1998). Hene, while the rationale underlying the use of real openness was supported in our data with the finding of the Balassa-Samuelson effet, we annot argue in favour of a robust relationship between real openness and labour produtivity for our ountry sample for the period We only find partial support for the sale effet. Population is statistially signifiant in our first-stage regression for openness only. Using population alone has no impat on labour produtivity. The theoretial rationale for inlusion of the variable in terms of the absorption effet finds no empirial support here. However, the area variable is signifiant and positive signed, thus onsidering the joint effet of area and population we are able to find a small positive effet of inreasing size with population density held onstant. The use of different data soures for labour produtivity reveals that this makes a substantial differene to the results of our analysis and the inferenes we an make. More researh is needed here to identify the soures of differene in the data that give rise to diverse results. This is where our further researh is to be direted. We also leave for further researh the analysis of the hannels through whih openness affets growth and produtivity in a dynami setting. 23

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