1. Does Trade Cause Growth? JEFFREY A. FRANKEL AND DAVID ROMER*
by ILKER KAYA

2. What is the impact of international trade on standards of living?
The big question
What is the impact of international trade on standards of living?

3. Technical Challenge
How are we going to measure the effect of international trade on income (standards of living)

4. Problems
The trade share may be endogenous: countries whose incomes are high for reasons other than trade may trade more.
There is not enough available data

5. Why this estimation is different?
In contrast to conventional gravity equations for bilateral trade, this trade equation includes only geographic characteristics: countries’ sizes, their distances from one another, whether they share a border, and whether they are landlocked.

6. Main assumption
A country’s geographic characteristics have important effects on its income through their impact on trade

7. We can use geographic characteristic as IV because;
Countries’ geographic characteristics are not affected by their incomes, or by government policies and other factors that influence income.
The instrument depends only on countries’ geographic characteristics, not on their incomes or actual trading patterns.

8. average income in country i is a function of
“international trade” and “within-country trade”,
and other factors:
(1) ln Yi = α + βTi + γWi + Єi.
Yi = income per person,
Ti = international trade,
Wi= within-country trade,
Єi = other influences on income.

9. international trade
(2) Ti =Ψ + ΦPi + δi
Pi=proximity to other countries,
δi= other factors
within-country trade
(3) Wi = η + λSi + νi
Si = the country’s size,
vi= residuals (other factors)

10. The residuals in these three equations, Єi, δi and vi, are likely to be correlated.
The key identifying assumption of this analysis is that countries’ geographic characteristics (their P ’s and S ’s) are uncorrelated with the residuals(Є ) in equation (1) and correlated with T and W

11. The main equation estimated;
N = population
A = area
L = dummy for landlocked countries
B = dummy for a common border between two countries.

12. Results of main estimation
Distance has a large and overwhelmingly significant negative impact on bilateral trade.
Trade between country i and country j is strongly increasing in j’s size.
If one of the countries is landlocked, trade falls by about a third.
Sharing a border has a considerable effect on trade.
The regression confirms that geographic variables are major determinants of bilateral trade.

14. Aggregate Trade ln(דij/GDPi) = a’Xij + eij, Tˆi = ∑j≠i e aˆ’Xij
estimation of the geographic component of country i ’s trade is the sum of the estimated geographic components of its bilateral trade with each other country in the world.
for all countries, not just those for which we have bilateral trade data

18. Estimates of Trade’s Effect on Income
ln Yi = a + bTi + c1ln N i +c2ln Ai + ui
Yi = income per person in country i
Ti = trade share
N i = population
Ai = area

19. Basic results
The regression shows a statistically and economically significant relationship between trade and income.
Controlling for international trade, there is a positive relation between country size and income per person.

20. Basic results continued
The coefficient on area is positive. The reason is sampling error or greater area has a negative impact via decreased within-country trade, but a larger positive impact via increased natural resources.
Using population alone to measure size has no major impact on the results.

22. Why Are the IV Estimates Greater Than the OLS Estimates?
The IV estimate is almost always considerably larger than the OLS estimate
There are two leading explanations
It is due to sampling variation.
OLS is in fact biased down.

23. Conclusions
There is no evidence that the positive association between international trade and income arises because countries whose incomes are high for other reasons engage in more trade.
The point estimates suggest that the impact of trade is substantial. The ratio of trade to GDP by one percentage point raises income per person by between one-half and two percent.

24. Conclusions
Increased size raises income. This supports the hypothesis that greater within-country trade raises income.
The impacts of trade and size are not estimated very precisely. As a result, the estimates still leave considerable uncertainty about the magnitudes of their effects.

26. THE END
PowerPoint is
And I learned how to use it……