Constructing an index of openness and its relationship with growth in India

Time-series work on trade policy and growth is handicapped by the difficulty of measuring 'trade policy'. Established definitions of trade orientation such as 'bias' or the 'effective rate of protection' are difficult to operationalise in a time-series context because of enormous data requirements. This paper tries to fill an important gap in the literature. For the first time it constructs a time-series index of openness for India based on the real exchange rate distortion, and then, using Johansen's maximum likelihood approach, examines its relationship with growth in India. It is found that while greater openness exercises a positive influence on growth, the effect of investment, contrary to conventional wisdom, is insignificant. This is in line with the Young-Currie-Kaldor view of endogenous growth which sees capital accumulation more as an effect than a cause of growth. This view is based on Adam Smith's famous dictum that the division of labour is limited by the size of the market. In this demand side approach, increasing returns result from greater specialisation, which in turn depends on the size of the market. The robustness of the results is reconfirmed by using the ARDL approach. JEL Classifications: F13, 020, 053 Keywords trade policy, index of openness, development theory and policy, India, time-series econometrics Introduction Over the past thirty years there has been an extensive debate on the relationship between trade policy and economic growth in developing countries