at =130 +I31Lt +I32t+I33t•Lt +ut (equation 1)
where Lt is a dummy equal to one for all t after the trade liberalization, and t is year. For convenience, for
this exercise you should let t start at t = 1.
The second measure will be constructed in the following way: Let sit be the average log per worker income
over all countries in year t. Country i’s distance to the average in year t is zi,t = yit – Let azi,t+1 = zi,t+1 -zi,t. You will estimate:
Azi,t+1 =130 + 131zi,t + I32zi,t • Lt + ui,t (Equation 2)
Equations 1 and 2 will not be sufficient to identify whether or not trade liberalisation has led to income
convergence or income divergence. You will construct control groups: countries which have not been party to
a trade liberalisation. Whether a country belongs to the liberalising or to the control group will be indicated
by the superscript j. In particular, Dj is a dummy equal to one if the country (or country group) is a liberaliser,
irrespective of when the country liberalised. You will estimate:
at =130 +I31Lt +1320j +133Lt •Dj +I34t+I35t•Lt +I36t•Dj +I37t•Lt •Dj +ujt (equation 3)
azi,t+1 =130 +I31zi,t +I32zi,t •Lt +133zi,t -Dj +134zi,t •Lt •Dj +ui,t (Equation 4)
1. First of all, explain equations 1-4, the meaning of the coefficients, and why estimating only equations 1 and
2 is not sufficient to identify the effect of trade liberalization. (10 marks)


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