How does international trade affect economic growth?
This question has a pedigree. A half-century ago, it was common for economists to observe that the second half of the 19th century had seen a large wave of globalization and also a large wave of economic growth across many countries. Seemed as if the two might be connected! Back in 1970, the economist Irving Kravis challenged this consensus by drawing what has become a classic distinction in his article, ”Trade as a Handmaiden of Growth: Similarities Between the Nineteenth and Twentieth Centuries,” Economic Journal (December 1970, 80: 320, Dec. 1970, pp. 850-872).
Kravis’s theme, which was controversial at the time and since, was that the connection from international trade to greater productivity did not arise primarily from an outright expansion of trade. He argued that in the 19th century, some growth success stories expanded their trade while others did not. Instead, Kravis argued, economic growth was usually driven primarily by domestic factors like investment and education, and the presence of trade (not necessarily its expansion) played a smaller complementary role in translating these changes into economic growth. Thus, he argued that trade was not an ”engine” of growth, but rather a ”handmaiden” of growth. For example, Kravis wrote:
”This evidence, it is argued below, does not support any simple generalisations about the dominant role of trade in the success stories of nineteenth- century growth. Export expansion did not serve in the nineteenth century to differentiate successful from unsuccessful countries. Growth where it occurred was mainly the consequence of favourable internal factors, and external demand represented an added stimulus which varied in importance from country to country and period to period. A more warranted metaphor that would be more generally applicable would be to describe trade expansion as a handmaiden of successful growth rather than as an autonomous engine of growth. …
”Perhaps the most important role played by trade is one that cannot be measured by trade statistics, viz., that a relatively open market enabled the growing country to find its areas of comparative advantage and to avoid the development of insulated, high-cost, inefficient sectors. In their direct impact, however, trade and capital movements were supplementary factors; they were handmaidens not engines of growth. The mainsprings of growth were internal; they must be sought in the land and the people, and in the system of social and economic organisation.”
There’s an ongoing argument in the research literature about how this argument applies to the 19th century evidence on globalization and growth. Those who are interested in the historical arguments can start by taking a look at ”Trade as a Handmaiden of Growth: An Alternative View,” by N. F. R. Crafts in the Economic Journal (September 1973, 83: 331, 875-884).
Here, I want to focus on the implications of Kravis's distinction at present. If trade is a main engine of growth, then it becomes important for trade to keep expanding as a share of GDP. If trade is a handmaiden of growth, then the presence of vigorous international trade is important, because it avoids what Kravis called ”the development of insulated, high-cost, inefficient sectors,” but continual expansions of trade don’t matter nearly as much.
It’s of course clear in the time since Kravis’s 1970 essay, certain countries like Japan, Korea, and China have experienced a wave of economic growth that is related to their access to international markets. However, it’s also clear that those countries have had very high levels of investment, as well as boosting the educational attainment and human capital of their population and being very willing to seek out and adopt new technologies. The US has had a large rise in its exports and imports in recent decades as a share of GDP, but economic growth in the US has fluctuated: fast in the 1960s, slow for much of the 1970s and 1980s, a surge roughly a decade long starting in the mid-1990s, and a growth slowdown since then. Up through about 2008, it was fair to say that the US economy has had globalization, but not a corresponding large and sustained surge of productivity growth as a result. Since then, the US has experienced both a slowdown in trade growth and a slowdown in productivity, but of course this correlation doesn'’t prove a causal connection between the two.
For a modern overview at the relationship between international trade and productivity, Gary Clyde Hufbauer and Zhiyao (Lucy) Lu lay out the background in”Increased Trade: A Key to Improving Productivity” (October 2016, Peterson Institute for International Economics Policy Brief 16-15). They point out:”Global trade growth slowed abruptly after 2010, following decades of expansion.” They also offer a nice overview of recent developments in trade theory. (Those who would like more on developments in trade theory might begin with the four-paper symposium in the Spring 2012 issue of the Journal of Economic Perspectives.) Toward the end of the paper, they develop a rule-of-thumb for measuring the gains from trade.
To understand their approach, remember that it's certainly possible to have an expansion of trade with no particular gain in GDP. Just consider an economy where both exports and imports rise by equal amounts, and the economy continues to produce the same amount. However, Hufbauer and Lu surveyed a number of studies about the effects of trade expansions and trade agreements on productivity. They argue that when trade expands, a certain percentage of that expansion represents efficiency gains from greater specialization in production and greater use of economies of scale. They write:
”[A] $1 billion increase in two-way trade increases potential GDP, through supply-side efficiencies, by $240 million. … Between 1990 and 2008, real US two-way trade in non oil goods and services increased at an average rate of 5.86 percent a year. If two-way trade had increased at this pace after 2011, the real value of US two-way non oil trade in 2014 would have been $308 billion greater than the observed value ($4.50 trillion versus $4.19 trillion). Based on the average dollar ratio of 0.24, the hypothetical increase in US two-way trade would have delivered a $74 billion increase in US GDP through supply-side efficiencies in 2014.”
If you put this number in context, it may not seem especially large. The US GDP was roughly $17 trillion in 2014, so an efficiency gain of $74 economy is less than half of 1%. To put it another way, say that the size of US trade as a percentage of GDP increases by 0.4% per year over time. Then about one-fourth of that amount (the .24 figure from the Hufbauer and Lu estimates) represents an efficiency gain. By this quick-and-dirty measure, trade might add 0.1% per year to the US growth rate.
Even that estimate may be too high, because the effects of trade on productivity and growth are likely to differ quite substantially across countries. A boost in trade for a small economy that has been closed off from competition can help bring that economy into global supply chains, in a way that spurs growth through access to global technology and global markets. But the US is a very large economy with a reasonably competitive domestic market. For that kind of economy, an additional trade agreement is likely to have a much smaller effect. A number of studies (going back to Kravis and earlier) point out that trade may be of greater relative importance for smaller economies, just as the North American Free Trade Agreement had a much larger positive effect for Mexico than the US economy.
But on the other side, the cautious reader may have noted that the Hufbauer-Lu estimate views trade from the ”engine of growth” perspective: that is, the gains from trade come from expansions of trade, not from the”handmaiden of trade” effects like a competitive incentive for domestic firms to improve their efficiency and to focus on expanding into areas where their efficiency advantages are greatest, or the efficiency gains from trade that arise from learning more about other markets and technologies–even if trade itself isn’t expanding.
It's also worth remembering that even seemingly small productivity gains, on the order of 0.1%, are cumulative over time. If several policies are all undertaken that can each raise growth by 0.1% per year, then after a few years the additional growth compounds to an economy that is noticeably bigger. A one-time gain of 0.1% of GDP in one year isn’t a lot, but a permanent and ongoing gain of 0.1% of GDP every year is actually of meaningful if modest importance.
Overall, the world may have reached a pause in globalization, defined here as a rise in trade relative to GDP. In that sense, trade as an engine of growth has probably slowed. In addition, the gains for the US economy from signing additional trade agreements, given the enormous size and vast internal trade already present within the US economy, are not likely to be large–and certainly not large in the short-run. Long-run growth for the US economy is more likely to be based on investments in human capital, physical capital, and technology. For smaller economies around the world, the possibility of greater participation in global markets can be considerably more important to their economic growth. For both large economies like the US and smaller economies around the world, the role of existing levels of international trade as a handmaiden of growth, providing competition and incentives and a check on industries that without such competition can become ”insulated, high-cost, inefficient sectors,” remains important.
Timothy Taylor is an American economist. He is managing editor of the Journal of Economic Perspectives, a quarterly academic journal produced at Macalester College and published by the American Economic Association. Taylor received his Bachelor of Arts degree from Haverford College and a master's degree in economics from Stanford University. At Stanford, he was winner of the award for excellent teaching in a large class (more than 30 students) given by the Associated Students of Stanford University. At Minnesota, he was named a Distinguished Lecturer by the Department of Economics and voted Teacher of the Year by the master's degree students at the Hubert H. Humphrey Institute of Public Affairs. Taylor has been a guest speaker for groups of teachers of high school economics, visiting diplomats from eastern Europe, talk-radio shows, and community groups. From 1989 to 1997, Professor Taylor wrote an economics opinion column for the San Jose Mercury-News. He has published multiple lectures on economics through The Teaching Company. With Rudolph Penner and Isabel Sawhill, he is co-author of Updating America's Social Contract (2000), whose first chapter provided an early radical centrist perspective, "An Agenda for the Radical Middle". Taylor is also the author of The Instant Economist: Everything You Need to Know About How the Economy Works, published by the Penguin Group in 2012. The fourth edition of Taylor's Principles of Economics textbook was published by Textbook Media in 2017.