Economic Reforms and Growth in Developing Countries

The last quarter of twentieth century has witnessed a dramatic decrease of restrictions in a number of areas such as international trade, capital account, and domestic financial sector in developing countries. Growth impacts of these liberalizations at large on the economy have long been investigated. Since the research to date focuses on the long-run impacts of reforms, much less is known about their short-run effects. Yet, this issue is important since possible short-run losses due to the adjustment costs may trigger dispute about the implementation of reforms. The aim of this paper is to answer the following questions: Is there any difference between short-run and long-run effects of reforms? Are reforms harmful in the short-run? What are the policy implications to alleviate the short-run costs of the reforms? In order to the aforementioned questions, this paper employs Pooled Mean Group (PMG) estimator developed by Pesaran et al. (1999). PMG estimator takes into consideration the cross-country heterogeneity and allows obtaining both the short-run and the long-run parameters of the model within the same estimation framework. Despite the short-run coefficients differ across groups, PMG estimator constrains the long-run coefficients to be homogenous over cross countries. This feature of the estimator is crucial for the research question of the paper since short-run adjustment to the reforms might depend on country-specific characteristics such as policy regimes and market imperfections. On the other hand, I expect that the long-run relationship between economic reforms and growth is homogeneous across countries. The main findings can be summarized as follows. In the long-run, international trade, capital account, and domestic financial reforms are positively associated with real per capita GDP. Moreover the positive long-run relationship between reforms and growth is robust to inclusion of de facto measures of reforms and quality of democracy variable. Having identified the long-run relationship, I take the short-run coefficients of the reforms for each country and analyze their determinants. Results indicate that, stimulating institutions preceding reforms is a prerequisite in order to mitigate the adverse short-run impacts. It is also worth noting that, countries gain from international trade reform already in the short-run provided that they are financially more closed.