Trade Openness and Economic Growth : Do Institutions Matter?

Abstract

Do lower policy-induced barriers to international trade promote economic growth in countries with poorly developed institutions? Several studies have found a general and positive relationship between trade openness and growth on average, but many of them are marred by methodological shortcomings and considerable unexplained variation in the results. I propose that good institutions of conflict management are a contingent and mediating factor that can help to explain data heterogeneity. Without such institutions, countries that integrate with world markets become vulnerable to external shocks, possibly unleashing domestic conflicts and uncertainty detrimental to growth. This hypothesis is given empirical support by analysing an interaction variable between openness and institutions, integrated in a growth regression for a sample of 94 countries. The interaction variable is positive, significant and robust to a standard list of control variables. For countries with the least developed institutions of conflict management, greater openness is ceteris paribus found to reduce growth rates. The results reveal the inadequacies of a ‘one size fits all’ approach to trade liberalisation, and indicate that complementary institutional reforms may be necessary if a country is to reap the full growth effects of openness.