Impact of Openness on Economic Growth and Human Development in South Asia

1. Middlesex University Department of Economics and Statistics Ghulam Mustafa G.Mustafa@mdx.ac.uk Openness, Economic Growth, and Human Development: Evidence from South Asian countries from 1990 - 2007 Results Table 1 Regression results for simultaneous equations model for South Asia using 3sls Introduction • Openness has a strong positive impact on economic growth [Eusufzai (1996 and 1998), Harrison (1996), Dollar (1992) , Barro (1991), Nourzad and Powell (2003)]. Openness seems to contribute positively to human development (Eusufzai (1996). • Human capital is stimulating economic growth in South Asia. This is consistent with “new growth theory” which suggests the significance of human capital for better economic performance (Barro 1991, Islam 1995). • The evidence shows that separately, FDI has a positive impact on economic growth. The interactive term between FDI and openness attempts to capture the effect of trade policy regime operating through FDI on economic growth. South Asia has been following EP policy and we can not reject the Bhagwati Hypothesis that the growth impact of FDI is greater under an EP regime compared to an IS regime. • There is positive association between economic growth and human development although it is not statistically significant. • Education and market size stimulate human development in South Asia. While FDI has a significant negative effect on human development. Urbanization seems to effect human development positively in the region. • Domestic investment and financial depth promote openness in the region. Market size and economic growth also contribute positively to openness. Despite a long existing debate in growth literature openness growth nexus is still an open question. But openness has been identified as promoting economic growth in developing countries (Cuadros et al., 2004). Even if the evidence of a positive effect of openness on economic growth is accepted the association between openness and human development is still open. The current analysis will extend the existing literature by studying the effect of trade liberalization on economic growth and human development in South Asia. Theoretical Model The growth equation is derived from an aggregate production function Y = f (A, L, K, H, OPEN, HDI) where Y is output (real GDP), L is Labour, K is capital stock, H is human capital stock, OPEN is the openness, HDI is Human Development Index and A captures the total factor productivity growth (TFP) on the growth in output. The endogenous growth theory postulates that A is endogenously determined by economic factors. FDI effects economic growth through A but the effect of FDI also depends upon trade policy. Therefore, we include the interaction term of openness and FDI in the model (Kohpaiboon, 2003). A = G (FDI, FDI*OPEN) Therefore, Y = f (A, L, K, H, OPEN, HDI, FDI, FDI*OPEN) Human development equation is derived from the following model HDI = f(Institutions) and Institutions = g (Openness, GDP, Education) Higher incomes produce better institutions (Rodrik and Rigobon, 2004) and institutions and trade jointly effect the economic growth (Dollar and Kraay, 2003). Openness has a positive impact on rule of law (Rodrik and Rigobon, 2004) and composite index of rule of law is used to measure institutional quality (Dollar and Kraay, 2003). Therefore, better education, higher economic growth and openness are expected to effect institutions which in turn effects human development. While the openness equation is based on the following function Openness = f( HDI, GDP, Market Size) The degree of openness can be determined by population and economic growth(Rodrik and Rigobon) and countries with better institutions tend to be more open to international trade (Dollar and Kraay, 2003) Summary and Conclusion The paper is an improvement over Nourzad and Powell (2003) in both model specification and econometric technique. The paper follows emerging endogenous growth theory in taking a stance that trade policies can affect the economic growth as technological change is endogenous and has a long run growth effect. This paper develops a simultaneous equations model for South Asia consisting of three equations to investigate the association between openness, economic growth and human development. The estimated results strongly support the hypotheses that openness and FDI have a strong positive impact on economic growth. The results should be applied more cautiously due to limited time series data. We suggest that deeper analysis of the link between openness, economic growth and human development is required at empirical and theoretical level. Data and Econometric Methodology The data for the study has been taken from World Development Indicators (WDI) 2009 provided by ESDS, Barro and Lee (2005) and Human Development reports published by UNDP. The empirical part of the analysis focuses on four countries only i.e. Pakistan, India, Bangladesh, Sri Lanka due to data availability. Human Development Index (HDI) is used as an indicator for Human Development. It is a summary measure of a country’s average achievement in attaining a long and healthy life, access to knowledge and standard of living. Openness is measured as the ratio of exports plus imports to GDP. I have used 3sls estimator for estimation of simultaneous equations model consisting of three equations. The 3sls is a combination of 2sls and SURE and is consistent and more efficient than 2sls estimator (Kennedy, 2009). The no of observations is 72 for all equations. The estimation results of country dummy variables and constant are not reported to conserve the space. *** Statistically significant at 1% level, ** statistically significant at 5% level, *statistically significant at 10% level.`