A look at the correlation between gross domestic product (GDP) and openness to trade.
Siddhesh Kaushik | World Bank
Julia Oliver | World Bank
A well-established correlation in trade economics is the connection between gross domestic product (GDP) and openness to trade: as countries become wealthier, they tend to trade more as a percentage of their gross domestic product (GDP).
The correlation is complex and not fully understood. As the authors of the World Bank’s Trade Competitiveness Diagnostic put it: “This relationship runs in both directions: the richer countries become the more they tend to trade; more importantly, countries that are most open to trade grow richer more quickly.”
Anything that might make countries grow richer more quickly is, of course, of great interest to developing countries and to development institutions such as the World Bank.
Some economic research has shown that openness causes growth – see the cross-country evidence provided by Jeffrey Sachs and Andrew Warner and the work of Marcus Brückner and Daniel Lederman in Africa, for example. But the empirical evidence is still questioned, in part because there are technical disagreements around the right way to measure trade openness and capture the relationship between trade openness and growth (see the literature review by Francisco Rodriguez and Dani Rodrik and analysis by Romain Wacziarg and Karen Horn Welch).
Our goal here is not to solve this dilemma. Rather, it is to let you see how the relationship of growth to trade openness unfolds in individual countries, using data from the World Integrated Trade Solution (WITS) platform — the World Bank’s gateway for trade data and analysis—and the World Development Indicators.
In the interactive scatterplot above, we show countries’ GDP per capita plotted against their openness to merchandise trade. In the interactive graph below, we look at the evolution of these two variables over time. You can look your country of interest on this visualization tool that compares trade openness with economic growth.
As you may discover, increases in trade openness are not always positively correlated with economic growth. The cross-country evidence indicates that this correlation actually turns negative at high levels of per capita income (around $22,000 in purchasing power parity, or PPP).
The main reason for this is that developed countries usually have large domestic markets and they also often shift to services trade as their GDP grows. All of this means that their goods trade as a percentage of GDP (merchandise trade openness) might actually diminish with economic growth.
A Closer Look
It is helpful to look at the context of a specific country to shed light on these economic patterns. One country that shows dramatic growth along with increasing openness in merchandise trade is Vietnam.
In the last quarter-century Vietnam has gone through a stark economic transformation. Political and economic reforms known as “Doi Moi” launched in 1986 began shifting the country from a centrally planned to a market economy. This process was accompanied by a jump in per-capita incomes from among the lowest in the world (less than $100 in 1990) to lower-middle-income levels ($1,960 by the end of 2013).
Among the components of these reforms was an embracing of outward-oriented trade and investment policies, including those that allowed businesses to engage in trade directly, rather than going through strictly-controlled trading companies.
The Philippines, on the other hand, has seen steady economic growth since 1999, even as its openness to trade in merchandise trade has diminished. This is because of the country’s specific development pattern: it has grown by using its comparative advantages in skilled labor and geographic location to build services industries, such as tourism and business process outsourcing.
In fact, the share of the service sector in the Philippines’ gross domestic product has exceeded that of the industry sector since the mid-1980s.
Of course, many factors that we are not taking into consideration here influence economic growth and trade openness. And the global recession has affected both income and trade in many countries, as you will see in the data. So it is important to look at this relationship as one in a much larger context. It is only a piece of the puzzle, after all. But, please, puzzle away here, with this visualization tool, and build your own investigation.
A quick note about the data:
- “Openness to merchandise trade” is the value of merchandise trade (exports plus imports) as a percent of gross domestic product (GDP).
- GDP per capita is calculated using purchasing power parity (PPP) in constant 2005 dollars.
- The data in the chart that shows time-series for individual countries is portrayed as a three-year moving average. This means that, for example, the value at the 2009 mark is an average of the 2008-2010 data.
- The data was extracted in December 2014.
This article first appeared on the World Bank Blog and was republished with permission.