TRADE LIBERALIZATION, INSTITUTIONS AND ECONOMIC GROWTH IN SELECTED SUB-SAHARAN AFRICAN COUNTRIES.

TRADE LIBERALIZATION, INSTITUTIONS AND ECONOMIC GROWTH IN SELECTED SUB-SAHARAN AFRICAN COUNTRIES.

BACKGROUND OF THE STUDY

According to North (1991), institutions are the humanly devised constraints that structure and control political, economic and social interactions amongst various economic agents. They consist of both informal constraints (sanctions, taboos, customs, traditions and codes of conduct); and formal rules (constitutions, laws, property rights). They are a set of economic, political and social factors, rules, beliefs, values and organizations that jointly motivate regularity in individual and social behaviour (Greif, 2006). They are of three types viz; economic, political and social. Economic institutions are essential for economic growth in any country due to their influence in shaping incentives for various economic actors in a society. They do not only determine the level of economic growth potential of a country, they also determine the distribution of resources and economic gains in the country. Political institutions, on the other hand, deal with the way the political structure in a country influences the behaviour of agents especially with regards to the distribution of political power - de jure and de facto (North, 1991; Acemoglu and Robinson, 2008; IMF, 2005). Institutions have been crafted by man to create a peaceful habitation and reduce uncertainty in the exchange of values. It is also believed that they play key roles in the management of economies in recent years. This is due to the fact that, it is becoming increasingly clear that those involved in economic transactions are not only influenced by economic variables (especially price) but also by a host of other factors that can be classified as institutions (Natal, 2001). Economic growth is a sustained expansion of production possibilities measured as the increase in real Gross Domestic Product (GDP) over a given period of time (Parkin, Powell and Matthews, 2008). The role of trade in economic growth and Page | 2 development is significant. The Classical and Neo-classical economists attached so much importance to international trade in a country’s development that they regarded it as an ‘engine of growth’. International trade increases savings and investment, reduces unemployment and under-employment, enhances greater backward and forward linkages in the economy and ensures a larger inflow of factor inputs into the economy and outflow of goods and services. Trade liberalization, has been defined as a move towards freer trade through the reduction of tariff and other barriers and is generally perceived as the major driving force behind globalization (Wacziarg and Welch, 2008). The Neo-classical economists believed that the economic growth of a country depends on the level of investment (Solow, 1956). Other scholars brought the concept of endogenous growth into the debate (Lucas, 1988; Romer, 1986). This was made more popular in the work of Mankiw, Romer and Weil (1992) that made human capital relevant to economic growth. Both the classical economists and the endogenous growth theorists seem to assume the institutions in countries affect economic activities. However, the insufficient benefits that accrue to developing countries from the global world suggest that there is more to economic growth and trade than implied by the neo-classical economists (Ige, 2007; Umo, 2001; Garba, 2003). The issue of whether trade and increased openness of trade would lead to higher rates of economic growth is an age-old debate between pro-traders and antitraders over the years. Pro-traders of free trade have lauded the gains from trade through the specialization of countries in the production of goods in which they have comparative advantage and engage in trade and exchange to meet their other needs. But the anti-traders see free trade to be the main cause of dumping of goods that have affected the developing countries adversely. New development theorists contend that openness to trade stimulates technological change by Page | 3 increasing domestic rivalry and competition, leading to increased innovation; and that trade liberalization by allowing new goods to flow freely across national borders increases the stock of knowledge for technological innovations which spur growth (Ahmed and Sattar, 2004). Countries in Sub-Saharan Africa (SSA) have implemented a series of economic reforms, including trade liberalization, with the aim of enhancing economic growth. The theoretical basis for these reforms is that trade liberalization is expected to increase trade, thereby increasing investment which in turn raises the rate of economic growth. However, the empirical evidence from the large and growing literature on trade and growth remains mixed. Edwards (1998), Rodriguez and Rodrik (2001) suggest that trade liberalization is not associated with growth; while Baliamoune (2002) and Yanikaya (2003) conclude that trade openness may even retard growth. For instance, while Sachs and Warner (1997) argued that trade openness increases the speed of convergence; the evidence from the study by Baliamoune (2002) suggested that increased openness to trade has led to income divergence rather than convergence in SSA countries. In fact, Rodrik (2001) argues that regarding trade openness and growth, “the only systematic relationship is that countries dismantle trade restrictions as they get richer”. There is a vast body of literature (North, 1991; Dollar and Kraay, 2003; Baliamoune-Lutz and Ndikumana, 2007; Flaig and Rottman, 2007; Kagochi, Tackie and Thompson, 2007; Siba, 2008; Mwaba, 2000; Gamberoni, von Uexkull and Weber, 2010; Bhattacharyya, 2011) which shows that trade and institutions have both positive and negative contributions to economic growth. Institutions can reduce or increase transaction costs because they determine the nature of exchange. They form a link for connecting the past with the present and the future - a kind of path dependency. Institutions provide the incentive structure of any Page | 4 economy because they create the structure that shapes the direction of economic change towards economic growth, stagnation, or decline. Therefore, trade liberalization and institutions enable exchange of goods to take place and results in economic growth. On the contrary, economic growth can also lead to trade openness and good institutional framework from the fact that when a country is experiencing growth, this growth would result in increased domestic and foreign rivalry and competition as well as increased institutional innovation. It has been observed empirically that one of the causes of the limited growth effects of trade liberalization is the weakness of institutions. Indeed, one strand of the literature on growth has argued for the predominance of institutions in economic growth (Easterly and Levine, 1997; Dollar and Kraay, 2003; Rodrik, Subramanian and Trebbi, 2004). Findings from empirical studies have concluded that institutions are crucial for the success of economic reforms in developing countries (Acemoglu, Johnson and Robinson, 2003; Dollar and Kraay, 2003; Addison and Baliamoune-Lutz, 2006). The evidence suggests that the failure of trade reforms to promote trade and growth in SSA countries is attributable to the poor quality of institutions. In a study by Addison and Baliamoune-Lutz (2006) on North African countries, the results of the study show that the growth effects of economic reforms depend to a large extent on the quality of institutions. It is in the light of the above, that this study examines how the institutions in the selected SSA countries can contribute meaningfully so that trade liberalization can have a noticeable impact on economic growth and increase the rate of investment that will boost the growth of aggregate output.

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