Trade, Markets and Economic Growth Harry Flam Institute for International Economic Studies, Stockholm University

Growth arithmetic X % doubles GDP per capita in Y years: 1 % - 70 years 3 % - 23 years 7 % - 10 years 10 % - 7 years

Standard growth theory Per capita GDP is determined by per capita stocks of physical and human capital, and productivity of capital stocks Investment in capital has diminishing returns Growth stops when investment yields just enough to cover depreciation of capital... unless total factor productivity grows

Growth accounting Construct stocks of physical and human capital by adding yearly investment and subtracting yearly depreciation Calculate weighted average of capital growth, using incomes shares as weights Subtract weighted average capital growth from output growth per capita Residual = total factor productivity growth

Total factor productivity, TFP Great variation in TFP across countries, both in terms of levels and in terms of growth rates Example: TFP growth explains 2 % of Singapore’s growth, 31 % of Hong Kong’s in Example: TFP grew at 0,5 % in U.S., Canada and Switzerland, and at 2 % in Finland and Norway

Trade: static effects Gains from specialization according to comparative advantage Economies of scale by producing for a larger market Less slack and less monopoly power from increased competition Greater choice for consumers and producers

Trade: dynamic effects Spillovers from domestic and foreign R&D Greater incentives to innovate when market is larger (?) Less redundancy in R&D

Trade and growth: evidence Need to find variable that is exogenous to GDP and correlated with trade (an instrument) Frankel and Romer: 1 per cent higher trade leads to 2 per cent higher GDP per capita More studies needed

Trade policy and growth: evidence Trade policy is usually part of set of policies. How isolate effects of trade policy? Trade policy hard to represent in single, quantitative measure Hard to interpret regressions of growth on trade policy All studies show that restrictive policy has negative effects on growth

Spillovers from foreign R&D Foreign R&D stock = trade weighted average of R&D stocks of trading partners Coe and Helpman: 60 % of variation in level of TFP explained by foreign R&D stock Keller: 70 % of R&D spillovers due to trade, 15 % due to FDI and 15 % to language skills

Markets and institutions Institutions: laws and judiciary, regulations and regulatory bodies, public policy, organizations, beliefs, culture Markets depend on the institutional environment Property rights protection is fundamental No single optimal set of institutions for all time and all countries exists Form is not always sufficient

Summary What explains growth and what explains great variation in growth? Standard theory: capital accumulation and total factor productivity Newer theory stresses dynamic effects through R&D and innovation Trade and FDI important channels of spillovers from foreign R&D Markets need good institutions