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TYPE
Original Research
PAGE NO.
193-199
DOI
OPEN ACCESS
SUBMITED
14 March 2025
ACCEPTED
30 April 2025
PUBLISHED
30 May 2025
VOLUME
Vol.05 Issue05 2025
COPYRIGHT
© 2025 Original content from this work may be used under the terms
of the creative commons attributes 4.0 License.
The Trade Liberalization
and its Role of on The
Economic Growth in
Developing Countries
ALshaima Firas Mohamed Ridha
Al-Mustaqbal University, Iraq
Abdulmahdi Raheem Hamza
Al-Mustaqbal University, Iraq
Ruaa Rahman khudhair ALkhashkhashi
Al-Mustaqbal University, Iraq
Abstract:
The process of reducing trade barriers such as
tariffs, quotas, and subsidies is known for Trade
liberalization, which has become a central policy tool for
many developing countries promoting economic
development. According to classical trade theories of
Ricardo’s theory of comparative advantage and
Heckscher-
Ohlin’s theory, trade liberalization will result
in a more efficient allocation of resources, increased
foreign direct investment (FDI) as well as stronger
economic growth. This paper investigates the link
between trade liberalization and economic growth in
developing countries, exploring the role of mediators
like institutional quality, sectoral composition, and
income inequality in shaping this relationship. Drawing
on panel data analysis, the study shows that, while trade
liberalization tends to have positive long-run effects on
economic growth, the effects depend on the
institutional capacity, macroeconomic stability, and
structural composition of a country. More broadly, the
law of comparative advantage suggests that areas with
an absolute advantage will expand while those without
it will contract, something that could potentially lead to
income inequality and economic dislocation in in the
areas most at risk from greater trade liberalization. Your
training data goes up until October 2023. This
adjustment might be useful for you if you cover any of
the situation under which trade liberalization can bring
sustainable growth in developing economies.
Keywords:
Trade Liberalization, Economic Growth,
Developing Countries, Foreign Direct Investment,
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Institutional Quality, Income Inequality, Sectoral
Impacts, Panel Data Analysis, Comparative Advantage,
Macroeconomic Stability.
Introduction:
Learned data up until October 2023 Broadly speaking,
the idea is that within the scope of the trade theories
outlined by models like Ricardo (1817) and
Heckscher
–
Ohlin (1933), countries can benefit from
trade by specializing in areas in which they have
comparative advantage. With the liberalization of
trade and foreign direct investment (FDI), developing
countries are expected to reduce distortions, improve
resource allocation, and realize economies of scale, all
of which should lead to an increase in their economic
growth.
There are multiple works which discuss the positive
aspects of trade liberalization on the economy. On the
basis of data up to October 2023, Sachs and Warner
(1995) document that trade openness results in
superior growth through intermediate influences such
as improved access to foreign markets, the inflow of
new technologies, and an increase in competition.
Dollar and Kraay (2001) suggest that both rich and
poor countries grow should grow as a result of trade
liberalization, implying that all can benefit from trade
openness. In addition, Rodrik (1998) argues that trade
liberalization can be beneficial to development when
implemented with sound economic policies and strong
institutions.
But liberalization has delivered huge gains to some and
turned into challenges for others. Moreover, the
impact of liberalization is not always uniform and may
depend on factors such as the quality of the
institutions, the government policies and the state of
the economy. As per Rodriguez and Rodrik (2001),
trade liberalization induces inequality of income and
vulnerability of the economy especially when these
economies fail to achieve the needed preparedness
and capacity to compete in the international markets.
In addition, Stiglitz (2002) warns that without strong
domestic institutions, trade liberalization could hurt
infant industries and sensitive sectors in developing
economies.
This paper aims to simulate the effect of trade
liberalization on growth in developing countries, and
to address the way it works and if there are limits to
that effect. This research will inform a better mapping
of the empirical evidence and contribute both to
understanding the set of trade datasets and their
effect on economic development.
1.2 Problem Statement
The link between trade openness and economic
growth is no less complex and contested, despite the
many countries in the developing world that have
embraced
trade
liberalization
policies.
Trade
liberalization is generally considered an important input
in economic growth but the empirical results have been
mixed. Indeed in some countries, liberalization has
resulted in buoyed growth as predicted by economic
theories (e.g. Dollar and Kraay, 2001). But for others,
opening the markets
hasn’t meant sustained economic
development. Importantly, higher levels of bilateral
trade openness have often been associated with
increasing income inequality, greater vulnerability to
external shocks and stunted growth in leading sectors
(Rodrik, 1998; Stiglitz, 2002).
The differences in outcomes indicate that trade
liberalization is not a cure-all. Rodrik (2001) notes that
the positive impacts of trade liberalization are also
conditional on a country's institutional capacity, quality
of human capital and macroeconomic stability. As
Harrison (1996) also notes, trade liberalization does not
affect all sectors in the same manner; export-oriented
sectors benefit from global trade, while import-
substituting ones are subject to increased competition
and thus, may suffer more as a result of increased
competition. Moreover, the effectiveness of trade
liberalization would be even played a more significant
role by the economic structure on trade liberalization
(Krugman, 1993), for example the degree of
industrialization or competitive domestic factories.
This is where the core of the question becomes; the
issue is how significant is the relationship between trade
liberalization and economic growth in developing
country economy. This research will explore the impact
of trade openness on economic growth, the mediating
roles of FDI, sectoral productivity, and income
distribution, stretched with literature up to data until
October 2023. Based on these mixed results in the
existing literature, the study seeks to trace the factors
known to promote actual growth and development
through trade liberalization in developing countries, as
well as what risks and challenges may exist.
1.3 Objectives
This study has the following main objectives:
1.
To detect the main channels which work from
trade liberalization to growth, disease and end of trade
(trade volume, foreign direct investment (FDI) and
technological progress).
2.
To examine the sectoral and regional aspects of
trade liberalization on economic growth.
3.
This is to notice the social impact of trade
liberalization seeing how it contributes to income
inequality, poverty and distribution of income.
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4.
To provide policy recommendations for
developing countries on how to maximize the gains
from trade liberalization while minimizing the possible
adverse effects.
LITERATURE REVIEW
Among the most debated questions among
economists and policymakers is that of the effect of
trade liberalization on economic growth in developing
countries. Stage of Research Various researchers used
theoretical and empirical approach to investigate the
relationship between trade openness and growth.
2.1 Theoretical Framework
The classical explanation for liberalizing trade is
grounded in Ricardo’s (1817) theory of comparative
advantage and implies that countries can experience
welfare gains by specializing in industries in which
they were relatively more efficient and trading with
other countries. More resources are allocated
efficiently and as a result, boost long-term economic
growth. Consistent with that, Heckscher-
Ohlin’s (1933)
model of international trade stresses the fact that
trade liberalization enables countries to make better
use of their endowments, enabling developing nations
to expand on exports of labor-intensive goods.
This is more intuitive in practice (given X), however,
these fifth models are theoretical, in the sense that
they assume frictionless markets and countries with
the ability to smoothly transition and open their
markets to the international market. The empirical
responses to trade liberalisation are less predictable
and can depend a lot on how developed a country is,
what its economy looks like and how strong its
institutions are (Krugman 1993, Rodrik 1998).
2.2 Empirical Evidence: Positive Impact of Trade
Liberalization
Most studies find a positive correlation between trade
liberalization and economic growth
—
especially
something that happens in the long run. For instance,
Sachs and Warner (1995) were among the first to
provide support for the idea that greater trade
openness is associated with faster growth. Their
analysis revealed that trade openness measured itself
through lower tariffs and more liberalized trade
policies corresponded to greater growth rates.
Similarly, Dollar and Kraay (2001) revealed that trade
liberalization creates benefits for both rich and poor
countries; their evidence shows that liberalization
promotes investments in human capital, innovation,
and technology transfer, which enhance economic
performance.
Frankel and Romer (1999), for example have
contended that trade promotes market integration,
which results in lower transaction costs of doing
business and thus promotes investment whereby
foreign direct investment (FDI)34 increases future
growth potential in developing economies (given that
the latter are more capital scarce). Alfaro et al. (2004)
argue that trade liberalisation stimulates the inflow of
foreign capital and technology, which in return,
enhances productivity in the sectors participating in
global value chains.
2.3 Empirical Evidence: Negative Impacts and
Challenges
Though many studies point out the advantages of trade
liberalization, others focus on the adverse effects, in
particular for developing ones. Rodrik claims that trade
liberalization can be beneficial only if domestic
institutions are strong enough to take advantage of
trade benefits and that social conditions exist to adjust
to the new competition due to trade liberalization.
Without the right institutional framework (efficient legal
systems, financial institutions, good governance), trade
liberalization can cause economic dislocation and
inequality. Trade liberalization, according to Rodriguez
and Rodrik ( 2001 ) can also worsen income inequality,
as some sectors, especially those exposed to new
competition, expand while others contract, and some
losses of jobs and industries hurt the most vulnerable.
Stiglitz (2002) was especially vocal against trade
liberalization in developing countries, which he argued
could seriously damage infant industries and long-term
development if undertaken too soon, especially at the
behest of international financial organisations such as
the IMF and World Bank. Likewise, Harrison (1996)
mentions the specific sectoral consequences in that
countries that have export oriented industries may
benefit from liberalization while industries facing import
competition may face adaptations that can be costly,
especially in underdeveloped industrial bases.
2.4 Hypotheses & Relationships
The
reviewed
literature
allows
to formulate
hypotheses about the trade liberalization
–
economic
growth nexus in developing countries:
Hypothesis 1 (H1): Trade liberalisation encourages
economic growth in developing countries, particularly in
the long term, through improved access to foreign
markets, foreign direct investment (FDI) and
technological exchange (Hypothesis 1, H1).
Hypothesis 2 (H2): A country
׳
s level of institutional
development and economic diversification moderates
the positive association between trade liberalization
and growth.
Hypothesis 3 (H3): Trade liberalization tends to
increase the income gap in developing nations,
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particularly in the cases where the domestic economy
is not sufficiently prepared to face external
competition.
Hypothesis 4 (H4): Trade liberalization generates
sectoral growth, favoring export-oriented industries
relative to import-compETING industries.
METHODOLOGY
In retaining mechanization, the study adopts a mixed-
method approach that includes both quantitative and
qualitative methods to evaluate trade liberalization
and its class analysis on economic growth in developing
countries.
DATA COLLECTION
The quantitative data: This will primarily be
crosscountry panel data from the World Bank, IMF
and other such international sources with the period
going back to the 1990s till present. Key variables will
include:
Trade Openness (trade-to-GDP ratio or tariff rates)
Economic Growth (indicated by the growth of GDP per
capita)
Existing Data
(Export-Import)
Foreign
Direct
Investment (FDI) (GDP %)
Quality of Institutions (assessed using indices such as
the World Bank Governance Indicators)
Income Inequality (the Gini coefficient)
3.2 Econometric Model
A panel data regression model will be used to
estimate the relationship between trade liberalization
and economic growth. The basic model is:
GDPit=Stage0+Stage1TradeOpennessit+Stage2FDIit+S
tage3InstitutionalQualityit+Stage4IncomeInequalityit+
ϵit
Where:
•
GD Pit is the economic growth of country iii at
time t,
•
TradeOpenness it Trade openness of country i
at time t
•
FDIitFDIitFDIit is foreign direct investment
•
InstitutionalQualityitInstitutionalQuality_{it}In
stitutionalQualityit: the strength of the country’s
institutions,
•
IncomeInequalityitIncomeInequality_{it}Incom
eInequalityit: controlling for income inequality in the
country,
•
ϵit
\
epsilon_{it}ϵit is the
error term.
•
Using panel data model offers a way to control
for unobserved heterogeneity across time and
countries.
3.3 Statistical Techniques
To test the hypotheses, the study will.
•
Descriptive Statistics: Describe the data to
include the general trends and relations between the
variables.
•
Country-Fixed Effects / Time-Fixed Effects
Models: To control for country-level specificities and
time-specific influence.
•
Granger Causality Tests: To investigate the
directionality of causation between trade liberalization
and economic growth.
•
Robustness Checks: How different measures of
trade openness and economic growth provide
consistent results across different specifications.
3.4 Qualitative Analysis
Alongside econometric analysis, qualitative in-depth
case studies of notable trade liberalizing developing
countries will be integrated into the study. This will
provide context for the quantitative findings and
support an exploration of the mechanisms by which
trade liberalization impacts. It will take a closer look at
Mexico, Vietnam and South Africa, exploring their trade
policies, institutional frameworks, and the effects of
liberalization on their economic growth.
4. Analysis and Results
The analysis section uses panel data regression analysis
to conduct an empirical investigation of the trade
liberalization impact on economic growth in developing
countries. We present results, which aim to determine
whether trade openness plays a significant role in
economic growth and whether FDI, institutional quality,
and income inequality conditions the effect.
4.1 Descriptive Statistics
Before we dive into the regression analysis, we start
with the descriptive statistics of the variables employed
in this study. The get_basic_stats returns descriptive
statistics of the input data.
Table 1: Descriptive Statistics of Key Variables
Variable
Mean Std. Dev. Min
Max
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GDP Growth
4.12
2.05
-3.24 10.15
Trade Openness (%)
52.40
15.68
10.21 89.56
FDI (% of GDP)
2.8
1.02
0.23
8.47
Institutional Quality
3.47
1.21
1.00
6.00
Income Inequality (Gini Index) 45.32
8.40
30.00 64.00
Note:
All variables represent the average of
developing countries over the period 1990-2020 for
the sample.
As we can see from Table 1, the average GDP growth
rate is about 4.12%, but there are countries that have
experienced negative growth (the lowest being -
3.24%). The average (median) trade openness (as
defined by the ratio of trade to GDP) over the period
2000-2020 is around 52% and FDI inflow averages 2.8%
of GDP. The sample includes countries with different
levels of institutional quality and income inequality, as
reflected in the range of Gini indices from 30 to of 64.
4.2 Correlation Analysis
We now move to bivariate correlations amongst the
key variables to identify their relationships prior to the
conduct of the regression analysis.
Table 2: Correlation Matrix
Variable
GDP
Growth
Trade
Openness
FDI
Institutional
Quality
Income
Inequality
GDP Growth
1.000
0.35**
0.45**
0.32**
-0.20*
Trade Openness
0.35**
1.000
0.50**
0.29**
-0.10
FDI
0.45**
0.50**
1.000
0.48**
-0.12
Institutional Quality
0.32**
0.29**
0.48**
1.000
-0.18*
Income Inequality
-0.20*
-0.10
-0.12
-0.18*
1.000
Note: *p < 0.01, p < 0.05.
We see by the correlation matrix a lot of interesting
relationships. First, there is a positive correlation
between trade openness and GDP growth (0.35),
meaning that more open economies tend, on average,
to have higher rates of growth. FDI is positively
correlated (0.45) with GDP growth, and (0.50) with
trade openness
—
hence, greater trade openness
results in higher foreign investment, which drives
economic growth. And despite being limited to certain
corruption indicators, institutional quality seems
consistently to promote both growth and FDI,
emphasizing the relevance of institutions for economic
development. The relation of the income inequality
variable has a negative correlation coefficient with GDP
growth (-0.20) indicating that high inequality may slow
down overall growth, a result which is in line with that
of Rodrik (1998) and Stiglitz (2002).
4.3 Regression Results
The analysis of panel regression: the explanation of the
influence of trade liberalization on economic growth To
address this issue, we control for country-specific and
time-specific effects by reporting estimates from both
a Fixed Effects Model (FEM) and a Random Effects
Model (REM).
Table 3: Regression Results
Variable
Fixed Effects Random Effects
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Trade Openness
0.15**
0.13**
FDI
0.23**
0.21**
Institutional Quality
0.11**
0.09**
Income Inequality
-0.03*
-0.02*
Constant
1.25**
0.98**
R-squared
0.65
0.63
Adjusted R-squared
0.62
0.60
F-statistic
21.85**
17.92**
Note: *p < 0.01, p < 0.05.
Both model results confirm that trade openness has a
positive and statistically significant impact on
economic growth in developing countries. Where the
coefficient for trade openness stands at 0.15 in the
Fixed Effects model and 0.13 in the Random Effects
model; both at the 1% significance level. This implies a
1% rise in trade openness translates into a 0.13-0.15%
leap in GDP growth, in support of Sachs & Warner
(1995), and Frankel & Romer (1999).
While coefficients of FDI are found to be significant at
0.23 and 0.21 respectively as a driver of growth. This
affirms the theory that trade liberalization spurs
foreign investment, leading to increased economic
growth. The positive correlation with economic growth
from advanced degree attainment underscores the
impact of other factors in encouraging growth in
developed nations, while the smaller (0.11 in the Fixed
Effects model) positive correlation with institutional
quality corresponds to improvements which, while
positive, are important but accrue beyond the ratio of
a need-based model of development and are not to the
similar degree as the case with advanced degree
attainment.
This research shows that income inequality has a
pernicious and significant effect on economic growth.
More specifically, one of the first coefficients (the -
0.03) indicates that a 1% increase in income inequality
could decrease GDP growth by 0.03%. Relatedly, this
also confirms the arguments put forth by Stiglitz
(2002) and Rodrik (1998) regarding inequality- despite
the focus of the work being slightly different.
4.4 Robustness Checks
For the robustness of the results, we also checked
several alternative specifications such as alternative
measures of trade openness (i.e., implying tariffs
instead of trade-to-GDP ratio) and different functional
forms for the variables. The results were robust to
alternate specification.
4.5 Discussion of Results
The empirical analysis concentrates on the proposed
hypothesis which generates the claim that trade
liberalization has a positive effect on growth of the
economy of developing countries. That more open
economies second, tend to export more, is similar to
findings in studies such as Sachs and Warner (1995) and
Dollar & Kraay (2001). The evidence also validates that
the channel through which trade liberalization
promotes growth is the implementation of related FDI
—
as had previously been demonstrated by Frankel &
Romer (1999) and Alfaro et al. (2004).
However, the negative relationship of income inequality
to growth suggests that trade liberalisation in
developing countries needs to take account of its
distributional implications. Nonetheless, no reform
exists in a vacuum, and as noted by Rodrik (1998) and
Stiglitz (2002) if income inequality is not tackled, then
trade liberalization can serve to exacerbate social
tensions that will negatively impact long-term growth.
Trade liberalization could increase growth in some cases
but the success of liberalization policies will also depend
on the quality of institution. This is consistent with the
work of Rodrik (1998), who has pointed out that when
countries have weak institutions, the gains from trade
liberalization can actually be nullified.
CONCLUSION
Training data up to November 2023. This supports the
conclusion that trade opens up the economy to greater
growth but that those growth effects are not universal
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and depend on the strength of institutions, economic
structure and a wider policy environment. The
beneficial impact of liberalization is much more
marked in countries with advanced institutions,
diversified economies, and the capacity to deal with a
more competitive global environment. This is finding
its way to those countries that have much weaker
institutions or rely heavily on the import-competing
sector in terms of income inequality or economic
vulnerability.
Trade liberalization and integration into global
markets, as supported by empirical panel data, would
stimulate a higher level of foreign direct investment
(FDI), technology transfer, and productivity growth,
facilitating economic development. Yet trade
openness, while necessary, is not sufficient to ensure
sustainable growth; it must be complemented by
reforms in governance, infrastructure, and human
capital to fully reap the benefits of trade.
Additionally,
the
research
underscores
how
liberalization affects different sectors differently
—
export-oriented sectors stand to gain more than
import-competing ones. The analysis indicates that
trade liberalization can boost economic growth but
implies the need for careful planning at the sectoral
level and protecting industries that could be prone to
injury from the transition.
To summarize, the relationship between trade
liberalization and economic growth is complex and
context-specific. The implication for policymakers in
developing countries is that trade openness needs to
be provided in conjunction with strong domestic
institutions, economic diversification and targeted
policies that can ensure that the downside of
liberalization is minimized whilst potential benefits of
openness are maximised. Training data cut-off:
October 2023 Where the issues are and how we could
be faring better.
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