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Stanford Business School Study Finds Fewer Borders, Trade Liberalization Support Economic Growth.

STANFORD, Calif. -- Borders restrict the free flow of people, goods and ideas, confining small nations with relatively fewer resources or markets while benefiting large countries with access to greater pools of capital, ideas, and buyers.

Redrawing maps has affected economic growth for both the new nations and their neighbors. To find out how, Stanford Graduate School of Business faculty member Romain Wacziarg, and Enrico Spolaore, assistant professor of political economy at Brown University, asked: "Suppose we removed the borders between two existing countries and then calculated what the growth would have been for the hypothetical country over the past 30 years. We would then be able to assess the costs or benefits of borders." Their research used data on the determinants of economic growth across countries.

"There's much less exchange of goods, finance, ideas" across borders, says Wacziarg who is associate professor of economics. When countries merge, each gains greater access to ideas, customers, and capital and therefore can anticipate economic benefits Wacziarg calls "the size effect." The researchers found that when two countries join, both almost always benefit economically, mainly because the larger size allows businesses better access to markets and capital. A limited form of political integration that would allow free passage across countries almost always has positive effects.

There are other benefits besides increased size. A poor country merging with a rich one stands to gain from access to improved growth fundamentals. However, there can be negative effects on the rich country. If there is full integration -- the borders are dropped and the two countries are allowed to share all their fundamentals -- the richer country is likely to see its human capital, savings rate, and average salary drop. It might also have to contend with worse infrastructure, a higher fertility rate, and a larger, more bureaucratic government. All these factors could put the brakes on the richer country's economy and work to diminish the size effect. The net effect of borders depends both on the size of the merged country and on preexisting levels of income.

A country's openness to trade is also important, the researchers found. The larger the country, the less likely it is to be open to trade with other nations. Because the larger countries already have access to more capital and customers, "they don't need to be as open," says Wacziarg. Therefore, if two countries merge, the resulting entity is less likely to be open to trade with other countries, chipping away at the benefits from the size effect.

The researchers found, however, that creating a really large new nation may outweigh other factors. If India, with a population of about 1 billion, and Pakistan, with a population of about 200 million, merged, both countries would benefit, even though Pakistan is poorer than India, says Wacziarg. "The size effect needs to outweigh the fact that the neighbor is poorer. I thought outside factors like human capital would swamp the size effect. But that's not typically the case."

Here's a look at some of the hypothetical countries the researchers explored and what their economic growth would have been over the last 30 years:

--Fully integrating the United States and Mexico would have reduced U.S. growth .07 percent, while Mexico's growth would have increased by 1 percent a year. That's because the United States is so large that a merger with Mexico would matter a lot to Mexico but very little to the United States. A merger between the United States and Canada would have produced a .07 percent growth rate for the United States, but a growth rate of more than 1 percent for Canada -- again, because the United States is so large.

--India would have benefited from merging with Pakistan and Sri Lanka but not with Bangladesh, which is significantly poorer than India. Brazil would have benefited from merging with most of its neighbors. If France and Germany had merged, both would have benefited as well. Wacziarg attributes these results to the size effect -- France and Germany have similar income levels, but each would have represented a large increase in the other's market size.

Wacziarg acknowledges nations have plenty of non-economic reasons not to merge. Nations don't want to share institutions, lose their culture and values, or see their sovereignty dissolve. The calculations can't shed full light on why countries don't try more aggressively to eliminate borders, but they do explore the purely economic costs and benefits of doing so.

Studying border changes is not just an academic exercise. The number of countries in the world has skyrocketed in the past 60 years. Consider the nations that sprang up after the Soviet Union broke apart or smaller countries that came into their own after decolonization in the 1960s. Today there are 193 countries, almost triple the number in 1945.

In addition to creating new borders, many countries have liberalized their trade policies that are essentially the same as economic barriers. Almost half the world's population now lives in open countries, up from 19 percent in 1960. (The percentage would be higher, but heavily populated India and China are still considered closed economies.) Seventy-three percent of countries are now open, up from 25 percent in the 1980s. That means almost half the countries in the world liberalized trade in the past 10 to 15 years. So, how does trade liberalization affect a country's growth? A lot. In another paper, Wacziarg and Karen Horn Welch of the Stanford Institute for International Studies explain that an open trade policy fuels a country's economy -- on average by about 1.5 percentage points per year. "There are huge returns," Wacziarg says.

Of course, as a country goes through reforms it often enacts other changes that also can boost the economy. This makes it difficult to isolate the effect of trade reforms per se. "Trade liberalization goes hand in hand with other reforms like privatization of state-owned companies," says Wacziarg. However, the researchers found that growth still increased in countries that liberalized trade policy without making other reforms.

Wacziarg says he was surprised by exactly how large the average effect of trade liberalization is on growth. Not only did growth increase, but investment rates and openness also increased dramatically. The average effect he calculates, however, masks interesting local specificities. Mexico, for instance, did not seem to have enjoyed the same benefits of trade reforms as Chile. He concludes: "Countries that followed through by deepening trade reforms over time did better. Active governmental disengagement from industrial policy and broad-based reforms were not necessary conditions for success. Countries that counteracted a short-lived program of external liberalization with domestic interventions did worse, as did countries that experienced tight macroeconomic policies, unfavorable terms of trade shocks, and political instability."
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Publication:Business Wire
Date:Aug 3, 2004
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