Trade Openness and Economic Growth in Malaysia

AuthorKeshmeer Makun
Publication Date01 August 2017
Date01 August 2017
02_FTR663317.indd Article
Trade Openness and
Foreign Trade Review
52(3) 157–170
Economic Growth in
2017 Indian Institute of
Foreign Trade
Malaysia: Some
SAGE Publications
Time-series Analysis
DOI: 10.1177/0015732516663317
Keshmeer Makun1,2
This study is an attempt to examine the effects of trade openness along with
two other conditioning variables on economic growth in Malaysia by applying
time-series econometric technique. LSE-Henry’s general to specific approach
results show significant positive effect of trade openness on growth. Human
capital and good economic policies tested with an interaction term increases the
growth effects of trade openness. The addition of these variables and findings
are significant statistically and robust to different specifications. On the basis of
the findings, it is concluded that while trade openness enhance growth, decision
makers should also focus on human capital development. In addition, decision
makers should ensure good economic policies to take full benefit of trade
JEL: C32, F11, F43
Trade openness, growth, time series approach
Trade openness has become one of the recent trends particularly in developing
and emerging market economies that are motivated to enhance their own eco-
nomic progress. The appropriateness of trade openness for economic growth has
been discussed time and again in the literature. The outcome of trade openness is
1 Dongbei University of Finance & Economics, China.
2 Fiji National University, Fiji.
Corresponding author:
Keshmeer Makun, International Institute of Chinese Language and Culture, Dongbei University of
Finance and Economics, No. 217 Jianshan Street, Shahekou District, Dalian 116025, China.

Foreign Trade Review 52(3)
scrutinized in a number of available empirical studies. Some studies suggest
significant positive effect of trade openness on economic growth (Dollar, 1992;
Edwards, 1998; Sachs & Warner, 1995). Others suggest small but positive result
of trade openness on economic growth (Lee, Ricci, & Rogobon, 2004). The suc-
cess story of the East Asian economies provide additional support to the view that
trade openness is useful for economic growth even though there are other deter-
minants of economic growth mentioned for these economies (World Bank, 1993,
2003). Further, the recent huge changes in the volume of trade in favour of China
shows economies that are open for trade are more productive than those who only
produce for domestic consumption without economies of scale. According to
Arrow (1962) international trade can bring about more research and development
(R&D) and learning by doing that is crucial for enhancing productivity and hence
economic growth. Beside trade openness, technological progress and human
capital are also considered as key determinants of economic growth (Borensztein,
De Gregorio, & Lee, 1998; Solow, 1956). This study begins with the remark that
even though trade openness is considered as one of the determinants of economic
growth, its impact differ substantially across economies and it depends on absorp-
tive capacity of the economy and sound economic policies.
In the beginning of the twentieth century, many developing economies such as
Malaysia have been largely regulated and protected economy with industrial reg-
ulation and highly regulated imports. However, as world trade policy changed
from import substitution to export promotion strategies in the 1980s, barriers to
trade and investment in Malaysia have declined relative to other economies in the
region except for Singapore and Hong Kong. This policy shift enabled Malaysia
to respond positively to increasing opportunities from worldwide trade expansion.
However, this generalized view does not suggest that all is good with trade in
Malaysia. The current account balance, which stood at around 16.8 per cent of
gross domestic product (GDP) highest in 2008, is on the decline and stood at 3.4
per cent of GDP in 2013. The growth engine changed remarkably from export-
oriented manufacturing to domestic services since global financial crisis in 2008.
However, Malaysia continues with its liberalization policies to raise production,
investment and diffusion of technology for more export-based industries.
The removal of restrictions on foreign equity participation in service sector, relax-
ation of foreign exchange policies, reduction in FDI caps particularly in export
industries and streamlining customs tariffs are evidence to be key aspect of export
growth during this period. Several studies have been undertaken to examine the
outcome of trade openness or liberalization on growth in Malaysia (see Sarkar,
2008; Yanikkaya, 2003); however, the last two decades are deemed very crucial to
get technical and structural changes. Trade policies have also been re-examined
and were revised. These changes in Malaysia’s openness and domestic economic
structure make her a suitable time series case study to examine trade openness and
economic growth nexus. There are two further grounds for undertaking the current
study. First, apart from some studies (Eaton & Kortum, 1996; Edwards, 1998;
Rodriguez & Rodrik, 2000) on trade and economic growth, a number of studies are
debatable on choice of the variable for they only choose trade openness while trade
openness alone may not enhance economic growth (Rodriguez & Rodrik, 2000).

Makun 159
The need to introduce important conditioning factors of growth is also empha-
sized in Bosworth and Collins (2003). This study takes this concern seriously and
seeks to overcome this by appropriately introducing additional variables namely
human capital and tests for sound economic policy with interactive term beside
trade openness in our specification. Human capital stock limits the absorptive
capacity of the developing economies (Nelson & Phelps, 1966). Thus, the gains
arising from trade openness in terms of technical know-how, research and devel-
opment and learning new ideas require sufficient level of human capital so that
the beneficial effect of trade openness is fully exploited. Similarly, sound eco-
nomic policies are important when economy opens up for international trade and
intend to realize the potential expansion of income from trade (Bolaky & Freund,
2004). Second, although research on trade and economic growth have proliferated
(Ahmed & Anoruo, 2000; Barlow, 2006; Chatterji, Mohan, & Dastidar, 2013;
Hye, 2012; Jawaid, 2014; Wacziarg & Welch, 2010), the focus has been on groups
and regions of economies. While this idea may be due to unavailability of
adequate yearly data, no such issue is present for Malaysia. Further, in cross-
sectional studies, it is difficult to gauge from across economies at specific point in
time as to what is happening in individual economy over time. A time series
analysis overcomes this issue with different econometric technique, providing
confidence and strong basis for acquainted economic policy decision. Motivated
by these premises and policy implications, this study aims to explore the effect of
trade openness on growth of output in Malaysia. Using LSE-Hendry general to
specific (GETS) technique and updated data over the period 1980–2013, this
study presents long-run estimates of trade openness and two other additional
variables on growth of output.
The remainder of the study is structured as follows. Following introduction,
the second section provides review of literature focusing on growth implications
of trade openness. The third section outlines the empirical modelling of the study.
The fourth section provides empirical results and discussion, and the final section
concludes the study with policy implications.
Review of Literature
Trade openness and economic growth nexus has been empirically tested for dif-
ferent countries using panel, cross-section and time series methods, and findings
differ substantially with some encouraging and some conflicting evidence.
Tyler (1981), Heitger (1987) and Lussier (1993) in a neoclassical framework
investigate the relation among export of goods and services, and economic growth
using ordinary least square method of estimation. The results indicate that export
is essential determinant of economic growth. Kraay (1999), using number of
industrial firms from China for the period 1988–1992, shows that their export has
lead to considerable development in firm’s productivity. Similarly, Park, Yang,
Shi and Jiang (2008) using Chinese manufacturing firms show that manufacturing
export increases their total factor productivity (TFP), overall sales and asset

Foreign Trade Review 52(3)
Gonclaves and Jurgen (1986) using sample of 70 developing economies ana-

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