The trade‐GDP ratio as a measure of openness

Abstract The ratio of trade to GDP is often used as a summary measure of a country's openness to the rest of the world. It is well‐known that the trade–GDP ratio is affected by relatively time‐invariant factors, such as country size and remoteness from trading partners, that can largely be controlled for in cross‐country panels by using country fixed effects. It is shown here that there are also other important, time‐varying influences on the trade‐GDP ratio that have been little investigated, such as the prices of commodity exports and imports, the real effective exchange rate, and the ratio of investment to GDP. These factors are shown to be significant, and not only in the short run, and need to be taken into account in estimating the long‐run effects of transport costs or trade policy on the trade/GDP ratio.