Trade, Foreign Investment, and Industrial Policy for Developing Countries 4089

Zoido-Lobaton measure of institutions, which is constructed from World Bank surveys

based on responses for 1997-1998. Yet the dependent variables in these two studies are
PPP GDP per capita prior to that period: 1985 PPP GDP per worker for Alcala and
Ciccone and PPP GDP per capita in 1995 for Rodrik et al. It seems odd to try to under-
stand growth in 1985 or 1995 using measures of institutions based on data from the
end of the 1990s, unless institutions change very little. Yet if institutions are not
time-varying, then they may simply be capturing the country fixed effect ai in Eq. (1).
While this survey has highlighted some of the shortcomings of cross-country work
on openness and growth, there are several promising new areas of research which
deserve mention. Most of the work surveyed so far uses real GDP per capita or per capita
growth as a measure of Y. Yet a number of studies have suggested that openness is
important because it allows countries to invest more. Levine and Renelt (1992) show
that there is no robust relationship between different measures of openness and average
per capita GDP growth in their cross-country sample. Replacing Y with investment
shares in GDP, however, they find that openness is robustly correlated with invest-
ment rates. They conclude that “the relationship between trade and growth may
be based on enhanced resource accumulation and not necessarily on the improved
allocation of resources.”
Levine and Renelt show that trade matters for growth because it increases invest-
ment. One mechanism could be by reducing the price of investment goods. Delong
and Summers show that countries with lower investment prices grow faster, and Lee
(1995) shows that a higher share of imported capital goods in total investment is asso-
ciated with higher growth. More recently, Hsieh and Klenow (2007) argue that on the
contrary there is no link between lower relative prices of investment goods and trade
policy. They cite as evidence the fact that the actual level of prices for investment
goods in poor countries is not higher than in the rest of the world. Instead, they argue
that investment rates are low in poor countries because the relative price of investment
is high relative to nontraded consumption goods, such as services.
The importance of barriers to investment in understanding linkages between trade
and growth is taken up once more by Estevadeordal and Taylor (2008). They estimate
a version of Eq. (1) in differences, but separate their measure of openness into tariffs on
consumption goods, intermediates, and capital goods. They also allow for a country
fixed effects in differences, leading to a difference-in-difference specification for (1).
They show that this approach successfully addresses the problem of whether institutions
or trade policy is responsible for higher incomes, since in first differences there is no
clear correlation between the two. In addition, they address the potential endogeneity
of changes in openness by using as instruments for the change the level of tariffs in 1985
interacted with two measures of what they refer to as “GATT potential”: GATT
membership in 1975 and a measure of diplomatic pressure constructed from number
of diplomats. Estevadeordal and Taylor show that tariff protection affects growth more