market, but that harms the other country; but a simultaneous proportional lowering of labor market frictions in both countries benefits both of them. With trade integration both countries benefit (even though it may raise their rates of unemployment), but the flexible country has higher total factor productivity in this model.

When that trade reform includes financial markets, more is gained than just a lower cost of credit. The resulting financial deepening can stimulate growth too (Townsend and Ueda 2007). Prasad et al. (2006) add two other indirect growthenhancing benefits of financial reform: they discipline firms to look after the interests of shareholders better and they discipline governments to provide greater macroeconomic stability.

Importantly from a policy maker’s viewpoint, the available empirical evidence strongly supports the view that open economies grow faster (see the surveys by USITC 1997, Winters 2004, Billmeier and Nannicini 2007 and Francois and Martin 2007). Notable early macroeconometric studies of the linkage between trade reform and the rate of economic growth include those by Sachs and Warner (1995) and Frankel and Romer (1999). More-recent studies also provide some indirect supportive econometric evidence. For example, freeing up the importation of intermediate and capital goods promotes investments that increase growth (Wacziarg 2001). Indeed, the higher the ratio of imported to domestically produced capital goods for a developing country, the faster it grows (Lee 1995; Mazumdar 2001). Greater openness to international financial markets also boosts growth via the stimulation to investment that more risk-sharing generates.

Rodrigeuz and Rodrik (2001) examine a number of such studies and claim the results they surveyed are not robust. However, in a more recent study that revisits the Sachs and Warner data and then provides new time-series evidence, Wacziarg and Welch (2003) show that dates of trade liberalization do characterize breaks in investment and GDP growth rates. Specifically, for the 1950-1998 period, countries that have liberalized their trade (raising their trade-to-GDP ratio by an average of 5 percentage points) have enjoyed on average 1.5 percentage points higher GDP growth compared with their pre-reform rate.

There have also been myriad case studies of liberalization episodes. In a survey of 36 of them, Greenaway (1993) reminds us that many things in addition to trade policies were changing during the studied cases, so ascribing causality is not easy. That, together with some econometric studies that fail to find that positive link, led Freeman (2004) to suggest the promise of raising the rate of economic growth through trade reform has been overstated. But the same could be (and has been) said about the contributions to growth of such things as investments in education, health, agricultural research, and so on (Easterly 2001). A more-general and more-robust conclusion that Easterly draws from empirical evidence, though, is that people respond to incentives. Hence getting incentives right in factor and product markets is crucial – and removing unwarranted subsidies and trade barriers is an important part of that process. Additional evidence from 13 new case studies reported in Wacziarg and Welch (2003) adds further empirical support to that view, as does the fact that there are no examples of autarkic economies that have enjoyed sustained economic growth, in contrast to the many examples since the 1960s of reformed economies that boomed after opening up.

Specifically, economies that commit to less market intervention tend to attract more investment funds, ceteris paribus, which raise their stocks of capital (through greater aggregate global savings or at the expense of other economies’ capital stocks). This is consistent with the findings by Faini (2004) that trade liberalization in the 6