The link between openness and income has received increasing attention as countries try to justify their trade-promoting policies. Recent work of Frankel & Romer (1999) examines the effect of trade on income. We explore how the estimates of the trade effect change when we relax their assumption of heteroscedasticity in the bilateral trade equation they use to construct the instrument for the IV regression. Because the instrument is constructed through a nonlinear transformation, unequal disturbance variances imply inconsistency and not just inefficiency of the Frankel–Romer estimates. We find a smaller positive effect of trade than that found by Frankel & Romer.
- Instrumental variable
ASJC Scopus subject areas
- Economics, Econometrics and Finance(all)