Openness and growth: Is the relationship non‐linear?

Using an augmented two‐sector endogenous growth model for a small, open economy characterized by human capital accumulation and productive government expenditure, we analyse the nature of the relationship between openness and growth. External openness enters the human capital accumulation function directly. Productive government expenditure affects human capital accumulation, relying on seigniorage revenue as finance where seigniorage is itself dependent on the level of openness. The findings indicate two, opposing effects of openness on growth ‐ a direct effect of openness on growth through knowledge spillovers that affect human capital accumulation, and an indirect effect of decreasing seigniorage revenue on growth through decreasing productive government expenditure on human capital. We discuss conditions under which the openness‐growth curve can be concave/convex, without specifying theoretical functional forms or values to unknown parameters in the model to provide concise theoretical results. Rather, drawing samples of exact model‐match countries over 1980–2011, we rely on a semi‐parametric, data‐driven empirical approach to provide empirical impetus to the theoretical outcomes reported. We show the relationship between openness and growth is non‐linear. Specifically, inverted U–shaped. The result suggests that openness only have a positive impact on the growth‐rate until a certain threshold‐level, thereafter, the effect is negative.