International Journal of Economic Perspectives, 2017

International Journal of Economic Perspectives, 2017, Volume 11, Issue 1, 165-172.

ECOWAS Regional Integration and Trade Effect: A Dynamic Panel Cointegration Method Using the Gravity Model Luqman O. AFOLABI* Universiti Utara Malaysia, School of Economics, Banking & Finance, Malaysia. Email: [email protected] (Phone: +60164288213)

Abu B. N. AZNIN Universiti Utara Malaysia, School of Economics, Banking & Finance, Malaysia. Email: [email protected] (Phone: +6049286802)

Azman A. M. IZRAF Universiti Utara Malaysia, School of Economics, Banking & Finance, E-mail: [email protected].

ABSTRACT Utilizing panel data set which consists of bilateral flow of export from 15 ECOWAS (Economic Community of West African States) countries for the period of 1983-2013, Panel Cointegration Method was used in estimation under gravity model which was espoused to test the significance of ECOWAS as a regional integration body. Comparing the results indicated a negative and significant coefficient of ECOWAS dummy variable for both dynamic ordinary least square (DOLS) and fully modified ordinary least square (FMOLS) estimators. Under pool ordinary least square (POLS), the coefficient of ECOWAS dummy is negative but not significant. The results suggest that there is trade diversion among the ECOWAS members. However, the results showcase the major essentials of properly accounting for endogeneity whenever trade policy effects are evaluated. JEL Classification: F15; F13; C33; F14. Keywords: RTAs; Trade Creation and Diversion; Panel Data Model; Gravity Models. *Corresponding author. 1.

INTRODUCTION

Trade has been an engine of growth in many nations. Many studies studied the role of trade in economic welfare and growth with this respect (Kaushal & Pathak, 2015; Sherif, 2013; Heidari et al., 2012; Katircioglu, 2012; Duasa, 2011; Leitao, 2011; Samet, 2011; Jenkins & Katircioglu, 2010; Katircioglu, 2010; Katircioglu et al., 2010a; 2010b; Katircioglu, 2009; Bayram, 2007; Onwuka, 2007; Soukhakian, 2007). Trade has been also proved as a major financing via exports of economies (Sodeyfi, 2016). On the other hand, a contradiction of the modern world is assumed that non-discrimination principle establishes the explicit trading systems that are multilateral, virtually all the members of the World Trade Organization (WTO) engaged in at least one regional integration agreement. The rapid increase of regional trade integration prompted many researchers to study the likely trade effects of regional integration. As at 1990s, regional trade agreements step up while some were still under negotiation. According to the trade report, it showed that as at January 2015 about 604 notifications of Regional Trade Agreements (RTA) have been scheduled to be executed while 398 were in force (WTO, 2015). Trade at the regional level has been comprehensively assessed using the gravity model framework of international trade (Sapir 2001). Regional trade integration creation has become the subject of discussion for non-academicians and academicians so as to justify its existence. ECOWAS was founded in 1975 by ECOWAS treaty. It consists of Gambia, Ghana, Burkina Faso, Cape Verde, Liberia, Guinea, Senegal, Togo, Nigeria ,Niger, Guinea Bissau, Mali, Benin, Cote d'Ivoire and Sierra Leone. Conferring to ECOWAS (2012), the population of ECOWAS zone is around 300 million with a GDP of approximately 316 billion Dollars; the region represented about 4.5% of the world populace but contributed only 0.5 per cent to the global GDP. Studies on ECOWAS regional integration are subtle thus the few available ones either discover a positive effect or no effect of ECOWAS regional integration. International Journal of Economic Perspectives ISSN 1307-1637 © International Economic Society http://www.econ-society.org

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International Journal of Economic Perspectives, 2017, Volume 11, Issue 1, 165-172. The mixed empirical findings might be due to some factors such as countries selected or the period chosen for the study. However, the RTAs' underlying theories were derived from Jacob Viner’s Customs Union Issue (1950). The theory introduced two concepts called as trade diversion and trade-creation so as to serve as proxies to measure the welfare of regional integration which was also used by numerous researchers such as Dam (1963), Cooper and Massel (1965) and Lipsey (1960). As at 1990s, studies on non-member and member countries trade effect of RIAs began such as: Krishna (1998), Baldwin (1993), Grossman & Helpman (1995), Levy (1994) & Bagwell and Staiger (1998) mainly on evaluating the compatibility proliferation trend in RIAs formation under WTO-governed trading system which are multilateral. The main objective of evaluating the regional trade integration is to ascertain whether multilateral trading system is contradictory or complementary; in order words, is also another way to confirm Bhagwati (1993) submission which tagged RIAs as 'stumbling blocks' or 'building blocks'. Regional trade integration is considered as one of the essential determinants of bilateral trade ties. This article examines the formational effect of regional integration agreements on intra-regional trade flows with the use of gravity model. Gravity model came to limelight as one the analytical tools in international trade studies which were initiated by Tinbergen (1962) and Poyhonen (1963). Gravity model improved further by Aitken (1973), Anderson (1979), Linnemann (1966), Bergstrand (1985), Deardorff (1998), Anderson and Helpman et al. (2008) and Van Wincoop (2003). This paper aims to contribute to the existing literature in two ways: First of all; this paper aims to check the general effect of ECOWAS regional integration agreements on trade flows among its members. Second, using panel cointegration, dynamic ordinary least square and fully modified ordinary least square for the selected data will give more robust results. For this purpose, this article introduces a dummy variable that is intended to serve as a proxy to check whether ECOWAS trade agreement increases trade among members, or there is an element of diversion. In this regard, newly developed techniques will be employed apart from POLS, which rely on panel cointegration exploration. This paper is divided into various sections namely: Subdivision 2 presents the methodological and data sources employed in this study while Subdivisions 3 and 4 cover estimation results and conclusion. 2.

LITERATURE REVIEW

New trade theory was developed by Helpman and Krugman (1985). This serves as the basis for return to factor proportion principle, also regarded to as Heckscher- Ohlin model (Heckscher 1919; Ohlin 1933), and gave an indepth explanation for patterns of trade in relation to relative factor abundance. Explicitly, countries with capital abundant that are specializing in producing goods on absolute advantage will tend to export goods that are capital intensive in nature, and then import labour that are intensive goods. The reverse holds for labour ample nations. Furthermore, Linder (1961) proposed a demand-based theory, which was used to explain the similarity in terms of trade demand features among the trading partners. Aggregating goods preference by importing goods from country j are related to the patterns of consumption in exporting country j. Thus, country j will tend to develop industries related to country j’s demand. Exchange of particular goods among countries will largely depend on production at continuous level and demand for related and differentiated goods. Combining demand and supply side of trade theories within Heckscher-Ohlin and Chamberlin Linder framework, GDP, and GDP per capita were identified based on their separate roles by (Bergstrand 1989). Moreover, Gruber and Vernon (1970) improved more on Linder’s hypothesis, by adding the differences of per capita incomes among two or more countries in absolute term into gravity equation in order to capture the likely consumption pattern differences. If negative coefficient is discovered, it shows that trade of both countries is positively related, and also the pattern of consumption and per capita incomes are linked which is in line with Linder hypothesis. Any positive coefficient supports the theory of trade. According to Helpman and Krugman's (1985) observation based on the data of trade among industrialized nations, it is discovered that industrialized nations can be explained better by their similarities instead of factor endowment differences. Helpman (1987) postulated the share of intra-industry trade that serves as the total value of partners involved in trade as a proxy to determine the relative country size and factor endowments that are in relative terms. In summary, Equation (1) adapts the cross-section specification using panel setting indicated by (Helpman 1987). The specification of triple indexed for gravity model was proposed by Matyas (1997), in order to serve as control variables represented by dummy. This effect of country-specific for country under export, also the importing country and the common shocks that can likely occur, can affect all the countries in the region. Some factors were highlighted by Hummels and Levinsohn (1995) as unique among countries and which might also vary depending on the characteristics of International Journal of Economic Perspectives ISSN 1307-1637 © International Economic Society http://www.econ-society.org

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International Journal of Economic Perspectives, 2017, Volume 11, Issue 1, 165-172. countries including: Cultural ties, border trade, trade restrictions of individual countries and seasonal trade. The study of Egger and Pfaffermayr (2003) considered these similiar factors. However, despite the tremendous increase of literature on panel unit root testing, cointegration gravity model variables were largely ignored. Thus, this study will evaluate the gravity model by adapting contemporary panel econometric procedures. 3.

METHODOLOGY & DATA

In order to specify the gravity model in a cross-sectional way, FMOLS , DOLS, and POLS specifications explicitly will comprise of time-invariant variables. Thus specification of the gravity model of bilateral export can stated as follows: .

(1)

Where: representing the export flows within 15 ECOWAS partner countries, was denoted using US dollars at constant 2000 prices: ECOWAS dummy is denoted by 1 when both countries became members of ECOWAS otherwise zero, thus this variable captures the trade effect of ECOWAS treaty accession of 1993. The similarity index can be calculated by the size of each country pair which was calculated using this formula: log 1

/



/

(2)

Relative factor endowments can be captured with GDP per capita by taking the absolute difference that are also in log form that given as: (ln . While the total GDP is the addition of both countries GDP taken into log that can be written as: (3) In order to incorporate the other components of gravity model to this study, then the theory specified variables must be included written as:

(4) variable was measured by using kilometers between the countries' capital cities for all exporting country under ECOWAS. represents the historical linkage and cultural background between all partners (ECOWAS). Logarithms was taken for all non-dummy variables. The nations include: Gambia, Ghana, Burkina Faso, Cape Verde, Liberia, Guinea, Senegal, Togo, Nigeria, Niger, Guinea Bissau, Mali, Benin, Cote D'Ivoire and Sierra Leone. The time period considered was 1983 -2013. Bilateral exports of 15 nations were used for panel estimation, with observations of 6510 (15 x 14 x 31). Data was sourced from the following sources: Flow of export for ECOWAS countries denominated in US Dollars was download from International Monetary Fund’s (2014) specifically under Direction of Trade Statistics that was denoted using US producer prices 2000=100. Per capita GDP and GDP, variables were sourced from World Bank Indicators Database that was reported in US dollars. Time-invariant variables that included distance and language were downloaded from CEPII. 4.

EMPIRICAL ANALYSIS

Based on panel unit root and panel cointegration testing, Gravity model variables was tested using panel unit root in order to determine the stationarity level before estimating the model. Panel unit root are of different types; panel unit root testing differs from time series approach due to stationarity or non-stationarity of the null hypothesis. Panel variant primarily depend on data that is balanced or unbalanced and whether cross-sectional dependence and heterogeneity are allowed or not. Table1 below shows the unit root test conducted using Im et al. (2003). The results show that all the variables are integrated at first difference I (1). International Journal of Economic Perspectives ISSN 1307-1637 © International Economic Society http://www.econ-society.org

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International Journal of Economic Perspectives, 2017, Volume 11, Issue 1, 165-172. Table 1. Panel Unit Root Results Level &

No of obs

First differences Constant

No of obs

6090

-5.34***

6090

Regressors

Constant

No of obs.

Total GDP

0.28

6090

Trend Constant 2.79

GDP Similarity

-1.92

6090

-3.76

6090

-5.92***

6090

GDPPC Exports

-1.84 -1.12

6090 6090

-2.00 2.37

6090 6090

-10.71*** -7.23***

6090 6090

Note: Null hypothesis testing for a unit root against the alternative in order to test the stationary of a series are computed using t-statistics (Im et al..2003). Bayesian information criteria (BIC) are chosen as the optimal lag in most of the cases. *** represent a significant level at 1%.

Cointegration test results using Pedroni (1999) are presented in Table 2. The panel statistics comprises of augmented Dickey –Fuller ADF 1979 t-statistics, variance ratio test represented by panel v and panel P that is called Phillips and Perron (1988). The cointegration test that is based on group statistics permits the presence of heterogeneity mainly on the coefficients at the long run. It can also accommodate both individual trends and intercepts into the equation. Table 2. Pedroni Panel Cointegration Test Results Equation ECOWAS1a ECOWAS1b

Panel v -0.77 0.86

Panel rho -2.80** -2.76**

Panel PP -15.46*** -15.33***

Panel ADF -4.39*** -3.45***

Group rho -0.92 -0.59

Group PP -14.46*** -13.41***

Group ADF -3.44*** -2.47**

Note: The test was conducted using residuals from the panel cointegrating regression, null hypothesis test of no cointegration against the alternative that all series are stationary (Pedroni 1999).ECOWAS1a permit heterogeneous intercepts; ECOWAS1b permit individual trend that have linear and intercepts. One lag length were specified as the maximum chosen by Schwarz info criteria. ***, ** represent significance level both at 1% and 5% respectively.

Table 3 presents the estimated result for gravity model of ECOWAS determinants. The DOLS and FMOLS estimators of cointegrating vectors take controls of likely endogeneity that might occur from the joint determination of exports and other variables. Concerning the parameters estimators as shown in Table 3, the coefficient signs accorded theoretical predictions. Total GDP and GDP similarity index are significant; the positive and significant sign of the coefficient Total GDP indicates that relative and economic size is a paramount tool for trade. GDP similarity index shows a negative and statistically significance in two of the estimates. While in the dynamic ordinary least square, the similarity index was not significant, can be more explained by the heterogeneity of our sample with ECOWAS that is between small and big economies. Many of the countries are similar in economy, have close and important trade relations. The coefficient of total GDP and GDP similarity are very high which is very common in literature (Egger and Pfaffermayr 2004), comparing POLS, FMOLS and DOLS show the importance of controlling heterogeneity biases. Looking at income per head variable, the positive and significance coefficient was only recorded by FMOLS that demonstrates that the development gaps between countries considered for estimates are mainly affecting the flow of exports. Distance has a negative sturdy effect on the volume of trade between 15 countries (ECOWAS). In other words, the wider the distance between ECOWAS countries the lesser they engage in trade. This result is in line with the classical gravity model results. An increase in the distance between countries I to j by 1% will lead to a decrease in export that can be on average 1.1%. The decrease is constant to all the estimates. Moreover, common language variable is positive and statistically significant indicating that two or more countries that share the same language that is official tend to stimulate trade among them (Kahouli and Maktouf 2013). It is imperative to discuss and analyze the impact of regional grouping using the coefficient of Intra- ECOWAS that is negative and significant in two out of the three estimates i.e., DOLS and FMOLS. There is export diversion, and the finding seems logical considering the small volume of trade within the members of the countries while most of the countries’ specialization and production are almost the same. International Journal of Economic Perspectives ISSN 1307-1637 © International Economic Society http://www.econ-society.org

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International Journal of Economic Perspectives, 2017, Volume 11, Issue 1, 165-172. Table 3. Gravity Model of Export Regressors Total GDP GDP Similarity GDPPC Distance Language

ECOWAS Obs

POLS 1.62*** (10.64) -.229*** (-4.42) .305 (1.09) -32.29**** (-9.01) .501 (0.85)

FMOLS 5.92*** (3.12) -.504*** (-7.36) .371*** (5.70) -33.76*** (4.69) .243*** (3.46)

DOLS 2.56* (1.76) .206 (-1.57) .569 (1.07) -27.41*** (-4.73) .184** (2.03)

.232 (0.41) 6090

-.424*** (-2.59) 6090

-.342 *** (-4.42) 6090

Note: *Heteroskedasticity robustness is reported in parentheses using test statistics (White 1980).DOLS and FMOLS are estimated using I(1) explanatory variables that are cointegrated and generated from a regression that involves two pre and post future values using first differences. Coefficients estimated under the first stage are substituted into equation (1) while the remaining parameters of the model are estimated (Bun and Klaassen 2007). *, **, *** Indicates significance at 10%, 5% & 1% respectively.

5.

CONCLUSIONS

The increasing number of RTAs over the years, most especially starting from mid-1990s, both the trade flows and its effect has received considerable attention. The unexpected negative impact on trade under RTAs among member countries can be captured using dummy variables within the framework of the gravity model. Gravity model became famous mainly because of the success achieved empirically including the simplicity and flexibility in explaining trade patterns. The purpose of this article is to examine the impact of ECOWAS on trade flow among members within the period of 1983-2013. The spread of regional trade has generated much criticism over the years. Mainly one of the criticisms in some quarters is the fear of trade diversion by passing of an effective non-member country towards member country less efficient particularly in terms of production. Within the study area, there is untapped potential for export to some partners within the member states. Based on the empirical results, ECOWAS member countries should move towards better regional integration in order to increase trade flows in order to promote the economic growth. However, the results indicated that policy makers need to develop and encourage a trade flow that will boost the economic development. Empirical results may help regional governing body of ECOWAS to identify the structural differences and react to the market needs. It is very important for ECOWAS to develop and encourage members to remove all the restrictive policy that hinders trade in order to achieve better performance. Another way that ECOWAS performance can be improved is the development of a robust policy on industrial production base in order to improve and enhance the capacity competitiveness of all members. Finally, it is very imperative for ECOWAS to move into another level of integration in order improve their performances. REFERENCES Aitken, N. D. (1973). The effect of the EEC and EFTA on European trade: A temporal cross-section analysis. The American Economic Review, 881-892. Anderson, J. E., & van Wincoop, E. (2003). nGravity with Gravitas: A Solution to the Border Puzzle, oAmerican Economic Review. March, 93(1), 170. Bagwell, K., & Staiger, R. W. (1998). Will preferential agreements undermine the multilateral trading system? The Economic Journal, 108(449), 1162-1182. Baldwin, R. (1993). A domino theory of regionalism: National Bureau of Economic Research. Bayram, T. (2007), Balassa-Samuelson Model Revisited : Growth Productivity Effect and Capital Accumulation, International Journal of Economic Perspectives, Volume 1, Issue 1, pp. 29-44. International Journal of Economic Perspectives ISSN 1307-1637 © International Economic Society http://www.econ-society.org

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