Many studies have found a positive correlation between trade and growth, but do not attempt to identify the economic mechanisms involved. In Discussion Paper No. 1331, Research Fellow Richard Baldwin and Elena Seghezza attempt to identify one of the mechanisms linking trade and growth.

A model is presented that establishes a link between trade liberalisation and investment-led growth, emphasising the role of traded intermediates employed in the capital formation sector and the capital intensity of traded versus non-traded sectors. Trade goods are an intermediate input into the production of new capital. Domestic protection raises capital's rental rate by shifting the derived demand for the fixed capital stock. If exports are also capital intensive, foreign barriers tend to lower the rental rate. Estimating equations are derived from the model and estimated with three-stage least squares on a cross-country data sample. The paper finds that domestic protection depresses investment and thereby slows growth. Foreign trade barriers also lower domestic investment, but the anti-investment effect is weaker and is less robust to sample and specification changes.