Exports-growth Nexus in Pakistan Cointegration and Causality Analysis

• Author: ADEEL SALEEM and MAQBOOL HUSSAIN SIAL

Abstract

This study empirically investigates the exports-growth nexus using annual time series data for the period 1973-2013 for Pakistan. Under augmented production function, it examines the effects of exports, human capital (pursuing new growth theory) and capital formation on GDP growth performance. The ARDL approach is employed to determine both the short-run and the long-run relationships. Moreover, the Granger causality test is used to explore causal direction among the variables. The empirical results show that real exports, real gross fixed capital formation, human capital, and real GDP are cointegrated when real GDP, real exports and real gross fixed capital formation are the explained variables. The short-run and the long-run coefficients conform to theoretical anticipation and demonstrate that exports, human capital and capital formation have a substantial and positive effect on GDP growth of Pakistan.

The Granger causality analysis reports bi-directional causality, running between exports and GDP growth in the short-run and the long-run. The study verifies the validity of ELG hypothesis in Pakistan. The study, therefore, suggests that a country like Pakistan should implement and enforce export promotion strategies as a part of its appropriate development strategy to get sustainable economic growth.

Keywords: GDP growth, Exports, ARDL, Pakistan

1. INTRODUCTION

   The importance of export expansion as an engine of economic growth has become a most debated issue in the field of economic development, growth, and trade literature with a little consensus among the experts. Several economists emphasize the significance of exports as a source of economic growth and have argued for various policies, for instance, export-led growth or import substitution strategies. The advocates of economic growth believe that it plays a fundamental role in the welfare of the society by improving the standard of living through an increase in per capita gross domestic product (GDP) of the economy. Increase in exports is perceived as a core determinant of output growth for developing as well as developed countries. Economic growth can be accelerated with the help of exports.

   Export expansion stimulates the production of goods and services through a variety of different possible channels like diffusion of technical knowledge, efficient allocation of resources, competitive atmosphere among firms, economies of scale, easy access to foreign exchange and higher imports of raw material and capital goods which result in higher capital formation. Hence, it stimulates domestic as well as export production in the economy (Khan et al., 1995; Esfahani, 1991; Begum and Shamsuddin, 1998; Moosa, 1999; Akbar and Naqvi, 2000; Chuang, 2000; Thangavelu and Rajaguru, 2004; Quddus and Saeed, 2005; Afzal, 2006; Awokuse, 2006; Chaudhary et al., 2007). It is known as ExportLed Growth (ELG) hypothesis in economic literature.

   The most important question in the exports-growth debate is, whether the export promotion policy is preferable to import substitution policy for the stimulation of economic growth of developing countries. The answer can be sought to analyze the direction of causation between GDP growth and export growth. The causality between output growth and exports has important policy implications for domestic policy makers.

   Trade is not only desirable but also inevitable, as countries have to provide for the growing needs of their economies. Several studies suggest a reciprocal relationship between export growth and GDP growth (Ahmed et al., 2000; Balaguer and Cantavella-Jorda, 2004; Chaudhary et al., 2007). Export expansion generates more income, which ultimately supports more trade (Abdulai and Jaquet, 2002). Numerous growing Asian economies got rapid economic growth, for example newly industrialized countries (NICs), i.e. Hong Kong, Philippines, Singapore, Taiwan, Indonesia, Malaysia, Thailand, South Korea and India. These countries have introduced various incentives to boost international trade using export-oriented strategies to improve their standard of living in the current era (Shan and Sun, 1998;

   Thangavelu and Rajaguru, 2004; Liu et al., 2009). Similarly, the South Asian countries have also achieved the target of economic growth through exportled growth and import substitution policies (Din, 2004). There are several countries that show good examples for export-led growth strategy (Federici and Marconi, 2002; Awokuse, 2003; Hossain and Karunaratne, 2004; Siliverstovs and Herzer, 2006; Chen, 2007; Awokuse, 2008). Therefore, the authenticity of ELG hypothesis is still on the agenda of the researchers in the developing and developed countries alike.

   According to endogenous growth theory, the long-run growth rate is determined on the basis of endogenous factors. The physical and human capitals both together are assumed to show increasing returns to scale (Hossain and Karunaratne, 2004) and trade or human capital work as an engine of economic growth (Lucas, 1988; Romer, 1990). The endogenous growth models give more emphasis on the role of research and development in technological change for achieving economic prosperity (Grossman and Helpman, 1991). Krugman (1986) and Lucas (1988) believe that trade promotes innovation, research and development spillovers, and learning by doing that leads to higher productivity growth. The export promotion strategies accelerate the process of human capital formation (Chuang, 2000). The recently emerging endogenous growth models highlight the value of exports towards GDP growth.

   As the level of exports increases, it is supposed to create more externalities and hence increase domestic production (Sengupta, 1993). However, various empirical studies (e.g., Balassa, 1978; Feder, 1982; Khan et al., 1995; Shan and Sun, 1998; Ahmed et al., 2000; Federici and Marconi, 2002; Awokuse, 2003; Abu-Qarn and Abu-Bader, 2004; Keong et al., 2005; Afzal, 2006; Chen, 2007) have examined this relationship and have concluded that exports have a positive impact on economic growth.

   During 1950s to 1960s, Pakistan focused on import substitution policy to improve balance of payment and to promote domestic industry. In 1970s, Pakistan switched over to export promotion policy by expecting optimistic consequences (Afzal, 2006). However, Pakistan shifted to an outwardoriented strategy more extensively in the late 1980s. Pakistan is particularly paying more attention on export promotion policy. To foster export growth, the government has implemented several development programmes for the promotion of export sector over the last decades, for example, exports bonus scheme, export subsidies, effective exchange rate, and export licenses during different times to encourage mostly manufactured exports. The total exports increased at the rate of 7.70 percent annually over the last thirty-four years (Quddus and Saeed, 2005; Afzal, 2006).

   The objective of this study is to present a comprehensive and rigorous time series investigation on exports-growth nexus for Pakistan. Given the ambiguity of results from earlier Pakistani studies, this study provides an extension in the empirical research work.

   The remaining paper is organized as follows: Section II presents a concise review of literature on exports-growth relationship. Section III explains and discusses data and methodology while empirical findings are presented and discussed in section IV. Finally, the conclusion of the study is provided in section V.

2. REVIEW OF LITERATURE

   Exports and Economic Growth Nexus

   The ELG hypothesis is among the most discussed topics in economic literature with quite diverse views and findings. Using cross sectional and time series data, various empirical studies verified and tested the validity of the ELG hypothesis with a mixture of outcomes. Several earlier studies (Emery, 1967; Syron and Walsh, 1968; Severn, 1968; Feder, 1982; Ram, 1987; Fosu, 1990) investigated the exports-growth relationship.

   These studies used rank and simple cross-correlation techniques under bi-variate model and applied ordinary least square (OLS) estimation method. The correlation coefficient explained high correlation between GDP growth and exports. The authors assumed this positive correlation as adequate evidence for ELG hypothesis. Nevertheless, this argument was extremely criticized due to improper econometric technique that generated spurious correlation and misleading outcomes (Ghatak and Price, 1997; Moosa, 1999; Shirazi and Manap, 2004; Keong et al., 2005). The second weakness is, only correlation does not indicate causation.

   In addition, the exclusion of essential relevant variables and bi-variate models create misspecification problem that produces spurious results regarding exports-growth relationship (Riezman et al., 1996; Shan and Sun, 1998; Ahmed et al., 2000; Abu-Qarn and AbuBader, 2004; Chaudhary et al., 2007; Halicioglu, 2007; Jordaan and Eita, 2007; Mahadevan, 2007). In the same way, cross-sectional studies unsuitably assume a common economic structure and identical production functions to verify the ELG hypothesis which is clearly against the reality (Federici and Marconi, 2002; Shirazi and Manap, 2004; Awokuse, 2006; Huang and Wang, 2007).

   Another group of studies analyzed this relationship by employing regression equations. A neo-classical production function along with a set of other explanatory variables is used to examine this relationship. The variable of export is used as a regressor in the neo-classical production function. If the coefficient of export variable is significant and positive, it confirms the validity of the ELG hypothesis (Pahlavani, 2005; Siddiqui et al., 2008). However, these studies also have the same weakness, that is, a significant positive relationship does not explain the causal direction between exports and economic growth (Ahmed et al., 2000; Awokuse, 2003).

   A number of studies (Chow, 1987; Hsiao, 1987; Bahmani-Oskooee...