Trade Openness, Growth and Role of Institutions : A Revisit Using Heterogeneous Panel Data Models

The fairly widespread view on the positive association between trade openness and income has been debated over the years due to serious estimation flaws prevailing in the cross-country empirical literature. This paper contributes to this debate by re-examining the long-run relationship between trade and income per capita with a focus on the role of institutions. It does so by estimating a heterogeneous panel data model with 97 countries over the period 1980-2012 that takes unobserved common factors into consideration. Our results suggest that trade remains positively and significantly associated with income, with estimates similar to those obtained in the literature that employs homogenous estimators with instrumental variable approach. We nevertheless believe that our method is a more appropriate approach to estimate the trade-income association given the potential cross section dependence and parameter heterogeneity associated with cross-country regressions. We further find that better quality institutions compliment the effects on income underscoring the significance of institutions in benefiting more from trade openness