Relationship between Exports and Economic Growth ...

European Journal of Social Sciences ISSN 1450-2267 Vol.32 No.3 (2012), pp. 453-460 © EuroJournals Publishing, Inc. 2012 http://www.europeanjournalofsocialsciences.com

Relationship between Exports and Economic Growth of Pakistan Athar Iqbal Assistant Professor, Iqra University Department of Business Administration, Main Campus, Karachi, Pakistan Tel: 0300-217-9808 E-mail: [email protected] Irfan Hameed PhD Scholar & Lecturer, Iqra University Department of Business Administration, Main Campus, Karachi, Pakistan Tel: 0333-550-30-36 E-mail: [email protected] Komal Devi MBA, Iqra University Department of Business Administration, Main Campus, Karachi, Pakistan Tel: 0333-237-9797 E-mail: [email protected] Abstract The nature of the relationship between exports and country’s economic growth has been one of the most debated topic in the recent past, yet with little consensus. Central to this debate is the question of whether strong economic performance is export-led or growthdriven. This question is important because the determination of the causal pattern between export and growth has important implications for policy-makers' decisions about the appropriate growth and development strategies and policies to adopt. This paper investigates the causality between exports and economic growth of Pakistan, through the application of econometric technique Granger causality by using real exports of Pakistan, real GDP of Pakistan, and real terms of trade of Pakistan. The results are based on annual data collected from 1960 to 2009. The empirical results from Granger causality technique clearly indicate that there exists unidirectional causality from GDP to exports in Pakistan but not vice versa.

Keywords: Exports, Gdp, Growth, Causality.

1. Introduction Economic development is one of the foremost objectives of every economy in the world and economic growth is primary to economic development. There are many contributors to economic growth. One of the elementary economic questions is how countries can accomplish economic growth. One of the answers to this question relies on the export-led growth (ELG) hypothesis which claims that export

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growth is a key factor in promoting economic growth. There exist a vast literature that discovers the link as well as direction of causation between country’s exports and country’s economic growth. An affirmative link between exports and economic growth has been identified for different countries by Balassa (1985), Ram (1987), Alam (1988), Greenaway and Nam (1988). Many other studies have not found any positive link between exports and economic growth. There could be the possibility of no link between exports and economic growth and there could be the link of any of the following types: The relationship of causality from exports to economic growth is called export-led growth. It could be interpreted as unidirectional causality from exports to economic growth but not vice versa. The export-led growth hypothesis (ELGH) assumes that export advancement is one of the key indicators of growth. It encourages that the overall progress of countries can be achieved not only by mounting the quantity of manpower and investment within the economy, but also by increasing exports. According to its advocates, country’s exports can act as an “engine of progress”. Another relationship of causality from growth to export is called growth-led exports and it tells that there is unidirectional causality from economic growth to exports but not vise versa. There is also a possibility of two way causality link from exports to growth and from growth to exports. The association between exports and growth is often attributed to the possible positive externalities for the domestic economy arising from participation in world markets, for instance from the reallocation of existing resources, economies of scale and various labor training effects. The competitiveness in global markets may lead to product innovation and force domestic producers to reduce various inefficiencies. According to Bhagwati (1988) increase in trade helps in producing more income (increased GDP) and more income smoothens the progress of more trade and the result being a ‘virtuous circle’. This type of feedback has also been identified by Grossman and Helpman (1991) in their research. Export expansion is believed to lead to and lead by an improved allocation of all types of resources, economies of time and scale, improvements in production techniques by widening knowledge and technical base, through multilateral international arrangements for transfer of technology, accumulation and formation of capital, raising the level of employment by jobs creation and thus, economic growth and development. In developing countries export promotion is a source to fill the imbalances in the external sector. It also assists the economic planners to ensure about the scale and pace of economic recovery. The concept of trade openness is from classical school of economics and from the theories of Adam Smith and David Ricardo. Theory of International Trade also relates trade and international development. Economic gains of specialization, discernible in enhanced exports, entails in higher levels of GDP, thus exports directly contributing to growth in national income. Thus contribute heavily to foreign exchange earnings and improving the balance of payment situation. It is argued that international trade or trade openness plays a significant role in country’s economic progress and there are economic gains from specialization. It has been commonly viewed that being a component of GDP, exports contribute directly to national income growth and are among the most important sources of foreign exchange earnings that lessen the strain on the balance of payments and create employment opportunities. Furthermore, opening the trade is also central in international concern about tariffs and trade barrier where trade theory suggests that all parties on aggregate will improve their welfare position in relation to their closed economy situation. The objective of this study is to test Export-led growth hypothesis for Pakistan. Export Led Growth is one of the most important economic strategies which are used by many developing countries. This strategy facilitates in seeking a niche in the world economy for a certain type of export. Industries generating this export may secure governmental subsidies and easy access to the domestic markets. By applying this strategy, many countries wish to gain enough hard currency to import goods manufactured less costly somewhere else.

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Export-led growth is significant for mostly two reasons. Firstly, the export-led growth strategy can generate profit, enabling a country to balance their investments, as well as surpass their liabilities as long as the schemes and materials for the trade items exist. Secondly, the much more arguable reason is that increased export growth can help to attain greater productivity, thus bringing ahead more exports in a higher spiral cycle. The strategy furthermore aspires at expanding the capability of making items that can contend in the world market utilizing sophisticated expertise and make provision for foreign exchange required to trade investment goods. Country’s Exports can assist the economy to incorporate in the world financial system and facilitate to condense the impact of exterior shocks on the domestic economy of a country.

2. Theorical Background Numbers of studies have been conducted to examine the link between exports and economic growth. Various studies have proved that there exists a strong relationship between exports and economic growth; however some have not proved any linkage. The starting point of the discussion on the link between a country’s economic performance and its exports can be traced back to the founding fathers of modern economic thought. Classical economists Adam Smith and David Ricardo laid emphasis on the significance of foreign trade for a country’s economic progress. They highlighted that a country could advantage considerably if it is expert in a certain product and then exported it to the international countries that lacked this product (Smith, 1776) and (Ricardo, 1817). There are several empirical researches to test the importance of exports in the process of economic development. In the context of East Asian countries, time series analyses that tested the ELG hypothesis, showed mixed results. For example, a study by Ahmad and Harnhirun (1996) tested the ELG hypothesis for five ASEAN economies (i.e., Malaysia, Indonesia, Singapore, Thailand, and the Philippines) over the period 1966-1986. They did not detect a co integrating relationship between the countries’ exports and their economic development. In fact, Ahmad and Harnhirun’s (1996) empirical findings indicated that economic growth had been causing the expansion of exports, and not vice versa. Chen (2007) tried to assess the validity of the Export-led Growth (ELG) and the Growth-driven Export (GDE) hypotheses in Taiwan by testing for Granger causality supported by the model called Vector Error Correction (VECM) and the bounds testing methodology developed by Pesaran (2001). The empirical results substantiate that a long-run level equilibrium relationship exists among exports, output, terms of trade and labor productivity of the model and that Granger causal flow between real exports and real output is reciprocal. Thus, the results attest to the advantage of the export-led growth strategy for continuous growth in Taiwan. Furuoka (2007) examined the relationship between exports and economic development in Malaysia. According to him, the results of the analysis do not sustain the “export-led growth” strategy. Rather, they lead to a conclusion that there exists a “virtuous cycle” or mutually reinforcing relationship between Malaysia’s exports and GDP in the long run. He also argued that the findings detected unidirectional short run causality from GDP to exports, but not vice versa. This means that the increase in Malaysia’s export tends to be an effect, and not the cause, of the country’s output expansion. Furuoka and Munir (2010) chose Singapore as a case study to examine the relationship between the origin of the East Asian Miracle (i.e. export dependency) and the economic growth. For this purpose, they employed causality test developed by Toda and Yamamoto (2005). The empirical findings indicated that despite a negative long run relationship between export dependency and economic growth, Singapore's heavy reliance on exports does not seem to have produced negative effects on the nation's economic growth. This was because the increase in export dependency was an effect, and not a cause, of the country's output expansion.


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All these theoretical complications could be sidestepped if there were convincing evidence that in practice trade liberalization systematically produces improved economic performance. But even for this relatively uncontroversial policy, it has proved difficult to generate unambiguous evidence (Yanikkaya, 2003). Siliverstovs and Herzer (2006) supported the export-led growth hypothesis for Chile in their study. Recently, Huang and Wang (2007) contributed an attractive discussion by examining the validity of export-led growth for the Newly Industrialized Economics (NIEs). Using the Johansen’s maximum likelihood cointegration procedures, the authors found evidence of cointegration at the 10% level for all the four economies. For developed countries, Martin (1992) used causality test and found that the ELG hypothesis is valid for Germany, United Kingdom, Japan, and the United States. Boltho (1996) investigated the strategy for Japan’s growth as twice as compared to other major industrialized countries in three periods of modern economic history (1913-37, 1952-73, and 1973-90). Five different tests were applied to investigate whether Japan’s growth in these years was export-led or not, and found that domestic market forces rather than foreign market forces drew longer-run progress. Harrison (1996) affirmed that the conception of openness, applied to trade policy, could be identical with the idea of neutrality. Neutrality means that inducements are unbiased between saving a unit of foreign exchange through import substitution and securing income of a unit of foreign exchange through international trade. Clearly, a highly export leaning economy may not be impartial in this regard, specially if it shifts incentives in support of export production with the help of ways such as export subsidies. It is also feasible for a government to be neutral on common, and yet get involved in particular sectors. A good measure of trade policy would capture differences between neutral, inward oriented and export-promoting regimes. Recently, the meaning of ‘‘openness’’ has become similar to the notion of ‘‘free trade’’, that is a trade system where all trade hurdles are terminated. That’s why, it is essential to understand this definition problem because various openness measures have different theoretical implications for growth and different linkages with growth. However, empirical studies are not usually clear on this issue as Edwards (1993) stated, the literature onto the issue has not always been successful in dealing with exact explanation of trade regimes, neither has it been competent to handle effectively the difficult issue of assessing the type of trade orientation pursued by a particular country. Khilifa (1997) analyzed the relationship between exports and economic growth and endorsed the hypothesis by confirming a positive and significant relation between the two variables for the period of 1973 to 1993. This studyis an attempt to find out the presence and direction of causality between two factors, export growth and economic growth. The method used was Granger causality. Onafowaro and Owoye (1998) examined the effects of trade policies (trade orientations) on exports, and investment rate on economic growth in 12 sub-Saharan African (SSA) countries over 1963-93. Using a vector error correction model (VECM) results indicated that trade policies, exports, and investment rate shocks have a significant impact on economic growth in 10 of the 12 SSA countries. This suggests that it is possible to stimulate economic growth in some African countries through an outward-looking strategy of export expansion. More significantly, the results further suggest the importance as well as the requirement for African countries to embark on trade liberalization policies in order to enhance economic growth in the current world economy. Lim, Chia and Mun (2009) were able to expose long run co integration association for South Korea and Singapore which is based on the Breitung (2001) rank test measures. Breitung (2001) rank test can help in detecting both cointegration relationships whether linear or non-linear, which indeed added value to the literature with strong support of cointegration (non-linear) on GDP growth and export. Awokuse (2003) re-examined the export-led growth (ELG) hypothesis for Canada by testing for Granger causality from exports to national output growth based on vector error correction models

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(VECM) and the vector autoregressive (VAR) methodology developed in Toda and Yamamoto (1995). The empirical results suggested that a long-run steady state exists among the model’s six variables and that Granger causal runs in unidirectional from real exports to real GDP. Panas and Vamvoukas (2002) investigated the causal links between exports and output growth in the empirical framework of the Greek economy, using error-correction modeling and multivariate Granger causality. A sensitivity analysis based on impulse responses is implemented to check the robustness of the results. The estimation procedure generates robust results, indicating that the ELGH is not valid in the case of Greece. Furthermore, the empirical findings suggest a strong and consistent causation from output growth to export performance in the long-run. Ramos (2000) investigated the Granger-causality between exports, imports, and economic growth in Portugal over the period 1865-1998. The role of the import variable in the investigation of exports output causality is emphasized, enabling one to test for the cases direct causality, indirect causality, and spurious causality between export growth and output growth. The empirical results do not confirm a unidirectional causality between the variables considered. There is a feedback effect between exports output growth and imports output growth. More interestingly, there is no kind of significant causality between import export growth. Both results seem to support the conclusion that the growth of output for the Portuguese economy during that period revealed a shape associated with a small dual economy in which the intra-industry transactions were very limited. There are also many studies analyzing the importance of exports in the economic growth specifically for developing countries. Most of these studies conclude that there is an affirmative link between exports and economic growth.

3. Methodology The main purpose of this research is to investigate causality between exports and economic growth of Pakistan. The study uses annual time-series data sets for the period 1970-2009. The main source of data is World Bank Development Indicators. The data used in the analysis is based on three variable Real Gross Domestic Product, Real Exports and Real Terms of Trade. The sample consists of 49 observations and the sample period is selected from 1960 to 2009 based on availability of data. 3.1. Model The empirical model used to test the relationship between real GDP and real exports and terms of trade can be specified by a simple model as: Y =f (X ,TOT) (1) where Y is real GDP, X is real exports, and TOT is the terms of trade. Two econometric tests are run in this study to analyze the regression model. Firstly, the unit root test is used to examine the stationarity of the data sets. The specific unit root test to check the stationarity of variables is used i.e. Augmented Dickey- Fuller (ADF). The ADF test is based on the following regression, ∆Yt = α +δyt-1+ µt (2) Where α is constant, δ is slope coefficient, t is a linear time trend, and µ is the error term. Secondly, this study uses Granger causality test to analyze the causality between exports and economic growth (Granger 1969). REXPt= c1+a1REXPt-1+…+akREXPt-k+β1GDPt-1+….βkRGDPt-k+ε1 (4) RGDPt= c1+a1GDPt-1+…+akGDPt-k+β1REXPt-1+….βkREXPt-k+ε2 (5) REXPt= c1+a1REXPt-1+…+akREXPt-k+β1RToTt-1+….βkRToTt-k+ε3 (6) RToTt = c1+a1RToTt-1+…+akRTOTt-k+β1REXPt-1+….βkREXPt-k+ε4 (7) RGDPt= c1+a1GDPt-1+…+akGDPt-k+β1RToTt-1+….βkRToTt-k+ε5 (8) RToTt= c1+a1RToTt-1+…+akRToTt-k+β1RGDPt-1+….βkRGDPt-k+ε6 (9) where c1 is constant; a1....... ak and β1…… βk are slope coefficients.

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The rejection of null hypothesis could indicate the causal relationship between the two variables.

4. Results, Finding and Interpretation of the Results The actual determination of whether a variable is stationary or non stationary is based upon the results of unit root tests. Numerous unit root tests have been presented in economic literature; the most common test, and the one which is utilized here, is the augmented Dickey-Fuller test. Table 4.1: Unit Root Test Results. Level Variable REXP 1% level 5% level 10% level RGDP 1% level 5% level 10% level RToT 1% level 5% level 10% level

C.V -3.571310 -2.922449 -2.599224 -3.574446 -2.923780 -2.599925 -3.600987 -2.935001 -2.605836

First Difference T-Statistic Probability

T-Statistic

Probability

1.055740

0.9966

-5.360606

0.0000

3.125269

1.0000

-2.811524

0.0641

-0.709406

0.8331

-9.544522

0.0000

The ADF unit root tests were employed to test stationarity of the time series data sets. Empirical results from the ADF test are shown in Table 1. As reported in the table, the obtained results indicate that the null hypothesis i.e. unit root exists is accepted as T-Statistic is greater than the critical values when calculated in level whereas the variables; RGDP, REXP, and RToT become stationary when calculated taking the first difference. In other words, we can say that RGDP, RToT and REXP variables are integrated of order one, I(1). Table 4.2: Granger Causality Test Null Hypothesis RGDP does not Granger Cause REXP REXP does not Granger Cause RGDP RTOT does not Granger Cause REXP REXP does not Granger Cause RTOT RTOT does not Granger Cause RGDP RGDP does not Granger Cause RTOT

F-Statistic 3.27551 1.29948 0.95744 2.38874 0.19870 2.65577

Probability 0.0345 0.2928 0.4255 0.0885 0.8964 0.0664

By looking at the probability values given in the table, this researcher concluded the results as follows. The Null hypothesis RGDP does not granger cause REXP can be rejected since the significant value is less than 0.05. On the contrary, the null hypothesis REXP does not granger cause RGDP can not be rejected. Thus it can be said that Granger causality runs one way, from RGDP to REXP, but not the other way. Further the hypothesis RToT does not granger cause REXP is being accepted and the hypothesis that REXP does not granger cause RToT is rejected and hence it can be concluded that there is unidirectional relationship between export and terms of trade. Finally the hypothesis that RToT does not granger cause RGDP is being accepted and the hypothesis that RGDP does not granger cause

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RToT is rejected and finally it can be stated that there is unidirectional relationship between GDP and terms of trade. The results of this study are matching with the results drawn by Furuoka (2007). He conducted his study for Malaysia using same methodology. Researchers like Jiranyakul (2010), Chen (2007), Furuoka and Munir, (2010), found opposite results of long run causality running from exports to GDP. Table 4.3: Hypotheses Assessment Summary S.No 1 2 3 4 5 6

Hypothesis RGDP does not Granger Cause REXP REXP does not Granger Cause RGDP RToT does not Granger Cause REXP REXP does not Granger Cause RToT RToT does not Granger Cause RGDP RGDP does not Granger Cause RToT

Sig 0.05 0.05 0.05 0.05 0.05 0.05

Probability 0.0345 0.2928 0.4255 0.0885 0.8964 0.0664

Conclusion Reject Accept Accept Accept Accept Accept

5. Conclusion In the light of above information, it can be concluded that there exist unidirectional causality, from RGDP to REXP, but not the other way. The studies conducted by Ahmad and Harnhirun (1996), Love & Chandra (2005). The importance of international trade and economic growth has been debated over the decades. The suitability of trade policy- import substitution or export promotion- for growth and development has been also debated in the literature. In 1950s and 1960s, most of the developing countries followed import substitution (IS) policy for their economic growth. Since mid-1970s, in most developing countries, there has been considerable shift towards export promotion strategy (EP). This approach postulates that export expansion leads to better resource allocation, getting economies of scale and production efficiency through technological development, capital formation, and employment creation and hence economics growth. The export-led growth has been focus of the economic debate. However, results are found to be contradictory. Moreover, findings of the recent studies, which are conducted with reference to Pakistan, are also contradictory. This study re-investigated the export-led growth hypothesis using Granger causality procedure to test the causal link between the exports growth and the real output growth in Pakistan over the period 1960 to 2009. The time series data for the said period were retrieved from World Bank development indicators.

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