This research work studies the international competitiveness of the Nigerian economy in the global market by analyzing the relationship between trade openness and output growth in Nigeria. Using time-series data over the period 1970-2007, we show that output growth of the Nigeria economy is a function of two sets of shocks; (i) external shocks (openness and real exchange rate) and (ii) internal shocks (real interest rate and unemployment rate). A non-monotonic and an ANCOVA econometric models are postulated in order to capture the structural pattern of the relationship between openness and output growth as well as the policy effect of structural Adjustment program (SAP). The result shows that there is an inverted U-shape (no-monotonic) relationship between openness and output growth in Nigeria and the optimum degree of openness for the economy is estimated to be about 67%. Also, the liberalization policy of the SAP has positive economic effect on the output growth. The ECM reveals that 79% of the equilibrium error is being corrected in the next period. We concluded that unbridled openness may have deleterious effect on the real growth of output of the Nigerian economy.
1.1 BACKGROUND OF STUDY
The current period in the world economy is regarded as period of globalization and trade liberalization. In this period, one the crucial issues in development and international economics is to know whether trade openness indeed promotes growth. With globalization, two major trends are noticeable: first is the emergence of multinational firms with strong presence in different, strategically located markets; and secondly, convergence of consumer tastes for the most competitive products, irrespective of where they are made. In this context of the world as a “global village”, regional integration constitutes an effective means of not only improving the level of participation of countries in the sub-region in world trade, but also their integration into the borderless and interlinked global economy. (NEEDS, 2005).
Since 1950, the world economy has experienced a massive liberalization of world trade, initially under the auspices of the General Agreement on Tariffs and trade (GATT), established in 1947, and currently under the auspices of the World Trade Organization (WTO) which replaced the GATT in 1993. Tariff levels in both developed and developing countries have reduced drastically, averaging approximately 4% and 20% respectively, even though the latter is relatively high. Also, non-tariff barriers to trade, such as quotas, licences and technical specifications, are also being gradually dismantled, but at a slower rate when compared with tariffs.
The liberalization of trade has led to a massive expansion in the growth of world trade relative to world output. While world output (or GDP) has expanded fivefold, the volume of world trade has grown 16 times at average compound rate of just over 7% per annum. In fact, it is difficult, if not impossible, to understand the growth and development process of countries without reference to their trading performance. (Thirlwall, 2000).
Likewise, Fontagné and Mimouni (2000) noted that since the end of the European recovery after World War II, tariff rates have been divided by 10 at the world level, international trade has been multiplied by 17, world income has quadrupled, and income per capita has doubled. Incidentally, it is well known that periods of openness have generally been associated with prosperity, whereas protectionism has been the companion of recessions. In addition, the trade performance of individual countries tends to be good indicator of economic performance since well performing countries tend to record higher rates of GDP growth. In total, there is a common perception that even if imperfect competition and second best situations offer the possibility of welfare improving trade policies, on average free trade is better than no trade.
From the ongoing discussion, it is evident that trade is very important in promoting and sustaining the growth and development of an economy. No economy can isolate itself from trading with the rest of the world because trade act as a catalyst of growth. Thus Nigeria, being part of the world, is no exemption. For this reason, there is a need to thoroughly examine the nature of relationship between trade openness and output growth in Nigeria.
1.1.2 TRADE OPENNESS AND OUTPUT GROWTH: HISTORICAL EXPERIENCE OF THE NIGERIA ECONOMY
Today, Nigeria is regarded to have the largest economy in sub-Saharan Africa, excluding South Africa. In the last four decades there has been little or no progress realized in alleviating poverty despite the massive effort made and the many programmes established for that purpose. Indeed, as in many other sub-Saharan Africa countries, both the number of poor and the proportion of poor have been increasing in Nigeria. In particular, the 1998 United Nations human development report declares that 48% of Nigeria’s population lives below the poverty line. According to the report (UNDP, 1998). The bitter reality of the Nigerian situation is not just that the poverty level is getting worse by the day but more than four in ten Nigerians live in conditions of extreme poverty of less than N320 per capita per month, which barely provides for a quarter of the nutritional requirements of healthy living. This is approximately US 8.2 per month or US 27 cents per day.
Doug Addison (unpublished) further explained that the Nigeria economy is not merely volatile; it is one of the most volatile economies in the world (see figure 1 below). There is evidence that this volatility is adversely affecting the real growth rate of Nigeria’s gross domestic product (GDP) by inhibiting investment and reducing the productivity of investment, both public and private. Economic theory and empirical evidence suggest that sustained high future growth and poverty reduction are unlikely without a significant reduction in volatility. Oil price fluctuations drive only part of Nigeria’s volatility policy choices have also contributed to the problem. Yet policy choices are available that can help accelerate growth and thus help reduce the percentage of people living in poverty, despite the severity of Nigeria’s problems.
Figure 1: growth rate of real GDP
Nigeria real GDP Growth Rate
During the period 1960-1997, Nigeria’s growth rate of per capital GDP of 1.45% compares unfavorably with that reported by other countries, especially those posted by china and the Asian Tigers such as Hong Kong, Singapore, Taiwan, and south Korea, viewed in this comparative perspective, Nigeria’s per capita income growth has been woefully low and needs to be improved upon. (Iyoha and Oriakhi, 2002). In like manner, ogujiuba, Oji and Adenuga (2004) wrote that the Nigerian economy has severally been described as a difficult environment for business with a population growth of about 3%, it has been acknowledged that the current average output growth rate of less than 4% will see the country being poorer in the next decade.
A study conducted by Iyoha and Oriakhi (2002) on Nigeria’s per capita GNP from 1964 to 1997 show that it rose steadily from US$120 to US$780 in 1981. Thereafter, it fell almost steadily to US$280 in 1997. Thus, between 1964 and 1981, income per capita increased by 550% or at an annual average rate of 32.3% while between 1981 and 1997, it fell by 64.1% or at an annual average rate of 4%. It is worth noting that if income per capita had continued to increase beyond 1981 as it did before then, Nigeria’s GDP per capita would have equaled US$1,279 in 1997. The difference between US $280 and US$1,279, i.e, approximately, US$1,000.00, is a rough measure of the cost to the average Nigerian of domestic macro economic policy mistakes and adverse international economic shocks. Likewise in 1960 agricultural exports accounted for only 2.6%. Exports of other commodities like tin and processed goods amounted to 26.6% of total exports. By 1970 agricultural exports only accounted for 33% of total exports while petroleum exports had started to establish dominance by exceeding 58% of total exports. By the time the oil boom began in earnest in 1974, petroleum exports accounted for approximately 93% of all exports. The relative share of agricultural exports in total exports had shrunk to 5.4% while other products accounted for the remaining 1.9%. Since 1974, with the exception of 1978 when the relative share of petroleum in total exports has exceeded 90%. In deed, since 1990, the relative share of petroleum in total exports has exceeded 96%. Agricultures contribution has fluctuated between 0.5% and 2.3% while the share of other products has fluctuated between 0.5% and 1.7%. Thus petroleum exportation has totally dominated the economy and indeed government finances since the mid-1970s.
Meanwhile, a puzzling and disturbing aspect of Nigeria export boom is that the growth it generated did not seem to be lasting or to have had a significant effect in changing the structure of the economy. For instance, in the 1970’s there was a major increase in measured GDP but the structure of the economy remained basically unchanged (see figure 2 below). This led professor Yesufu (1995) to describe the Nigerian economy as one that had experienced “growth without development’’.
Figures 2: trend of real GDP
During the period of 1970 – 1985, import substitution industrialization (ISI) strategy was a dominant feature of trade policy in Nigeria. The trade policy was generally inward oriented. Under this ISI strategy, “Infant” manufacturing industries were protected using high tariffs, import quotas, and other trade restrictions like import licensing. Non-tariff barriers to trade such as import prohibitions were also utilized. During this period, trade policy was also adjusted in response to the exigencies of the balance of payments.
Also, Nigeria was operating a fixed exchange rate regime under which the value of the Naira was essentially tied to US dollar and gold. It is worth noting that the trade policy pursued during this period resulted in a rapid increase in manufacturing production and employment, particularly during the era of the oil boom (1975 -1980) and that led to a rise in the share of manufacturing in Gross Domestic product (GDP) from 5.6% in 1962/63 to 8.7% in 1986. (Iyoha and Oriakhi, 2002).
In 1986, Nigeria adopted the structural adjustment programme (SAP) of the IMF/World Bank. With the adoption of SAP in 1986, there was a radical shift from inward-oriented trade policies to out ward –oriented trade policies in Nigeria.
These are policy measures that emphasize production and trade along the lines dictated by a country’s comparative advantage such as export promotion and export diversification, reduction or elimination of import tariffs, and the adoption of market-determined exchange rates some of the aims of the structural adjustment programme adopted in 1986 were diversification of the structure of exports, diversification of the structure of production, reduction in the over-dependence on imports, and reduction in the over-dependence on petroleum exports. The major policy measures of the SAP were:
· Deregulation of the exchange rate
· Trade liberalization
· Deregulation of the financial sector
· Adoption of appropriate pricing policies especially for petroleum products.
· Rationalization and privatization of public sector enterprises and
· Abolition of commodity marketing boards.
However, as a result of trade liberalization gospel of the SAP, the Nigeria external sector really experience dramatic growth. For instance, the total domestic exports of Nigeria in 2006 amounted to N755141.32 million against N6621303.64 million in 2005 showing an increase of 14.10%. Domestic exports recorded negative growth rates in 1993 (7.70%), 1994 (45.5%), 1997 (2.03%), 1998 (38.48%) and 2001 (27.06%); while it recorded positive growth rates in other periods. The largest increase in domestic exports was witnessed in 1995 (448.42%). Total imports (C.I.F) stood at N2922248.46 in 2006 as against N1779601.57 million in 2005 recording an increase of 64.20%. Total imports also recorded negative growth rates in 1994(45.72%),1998(9.41%) and 2004(18.07%) while it is positive all through other years. The value of total merchandise trade amounted to N10477389.78 million in 2006 as against N45272.24 recorded in 1987. External trade was dominated by domestic exports between 1987 and 2006 averaging 67.17% while imports (C.I.F) averaged 32.82% (see figure 3 below), consequently, the trade balance was positive between 1987 and 2006. Oil export remains the dominant of export trade in Nigeria between 1987 and 2006 accounting for about 93.33% of total domestic exports. On the other hand, non oil exports accounted for a small value of 6.67% over the same period. (NBS report, 2008).
FIGURES 3: GROWTH OF EXPORT AND IMPORT
NIGERIA IMPORT AND EXPORT
Therefore, it could be understood that the SAP involved the deregulation and liberalization of the Nigerian economy. This policy thrust of this program dovetailed nicely with the emerging international orthodoxy to the effect that deregulation and economic liberalization would yield the optimal allocation of scarce resources, reduce waste, and promote rapid economic growth in developing countries. Unfortunately, there has been no significant progress made in the achievement of these objectives. The openness of the economy has significantly increased in the past four decades, with the trade-GDP ratio rising from 31.54% in 1970, to 46.91% 1980, 57.23% in 1990, 88.16% in 1995, 85.26% in 2003 and 57.63% in 2007 (see figure 4 below) indeed, in the 1990s the ratio of trade to GDP has averaged 70%. This extreme openness of the economy could be disadvantageous in that it makes the country highly susceptible to internationally transmitted business cycles, and, in particular international transmitted shocks (like commodity price collapse). A good example of this effect on the Nigerian economy is that of the global food crisis of 2007 and the current global economic/financial crisis.
FIGURES 4: THE DEGREE OF OPENNESS
NIGERIA IMPORT AND EXPORT
1.2 STATEMENT OF THE RESEARCH PROBLEM
Nwafor Manson (unpublished) not that the Nigeria’s trade policy over the years has been determined by one/ more of the following.
· Need to protect and stimulate domestic production (import capital goods at low prices etc)
· Need to ameliorate/prevent balance of payment problems.
· Need to boost the value of the naira
· Need to be competitive and enjoy the benefits of openness.
· Need to increase revenue and
· International agreements
Today, as part of moving with the trend of globalization and trade liberalization in the global economic system, Nigeria is a member of and sygnatory to many international and regional trade agreements such as international monetary fund (IMF), world trade organization (WTO), economic community of West African States (ECOWAS), and so many others. The policy response of such economic partnership on trade has been to remove trade barriers, reduce tariffs, and embark on outward-oriented trade policies. Despite all her effort to meet up with the demands to these economic partnerships in terms of opening up her border, according to the 2007 assessment of the trade policy review, Nigeria’s trade freedom was rate 56% making her the worlds 131st freest economy while in 2009, it was ranked 117th freest economy, the country’s GDP was also ranked 161st in the world in February, 2009. The economy has struggled vigorously to stimulate growth through openness to trade, In fact, it seems that as the country put greater effort to boost her economic growth by opening up to trade with the global economy the more she becomes worse-off relative to her trading partners in terms of country output growth.
Having reviewed the related literatures and considering the structure of the Nigerian economy as related to trade openness and output growth, we may then ask the following questions.
· Does trade openness have any significant impact on out put growth in Nigeria?
· Is there any other macroeconomic variable that has significant impact on output growth in Nigeria?
· Is there any linear association (correlation) between trade openness and output growth in Nigeria?
· Is there long run relationship between trade Openness and output growth in Nigeria?
· Has there been any significant structural change in output growth between the pre-SAP and post-SAP period in Nigeria?
1.3 OBJECTIVES OF THE STUDY
The broad objective of this research work is to study, in its entirely, the relationship between trade openness and output growth in Nigeria. This broad objective can be subdivided into the following smaller objectives:
· To examine the impact of trade openness on output growth in Nigeria.
· To identify other internal and external macroeconomic shocks that determine output growth in Nigeria.
· To identify other international and external macro economic shocks that determine output growth in Nigeria.
· To determine the linear association (correlation) between trade openness and output growth in Nigeria.
· To ascertain the possibility of long run relationship between trade openness and output growth in Nigeria.
· To determine the possibility of structural changes (if any) in output growth between the pre-SAP and post-SAP period.
1.4 STATEMENT OF THE RESEARCH HYPOTHESES
In view of the foregoing study, with respect to trade openness and output growth in Nigeria, the following null hypothesis will be tested:
Ho: Trade openness does not have any significant impact on output growth in Nigeria.
Ho: There is no other macroeconomic variable (internal and external) that have significant impact on output growth in Nigeria.
Ho: There is no linear association (correlation) between trade openness and output growth in Nigeria.
Ho: There is no long run relationship between trade openness and output growth in Nigeria.
Ho: There is no significant structural change in output growth between the pre-SAP and post-SAP period.
1.5 JUSTIFICATION OF THE STUDY
Nigeria is currently undergoing a series of transformation in every sector of the economy, including the external sector of the economy. The country’s economic policy in the last two decades had one dominating theme which is an integral part of the structural Adjustment programme (SAP) – trade liberalization. This policy was espoused on the argument that it enhances the welfare of consumers and reduces poverty as it offers wider platform for choice from among wider variety of quality goods and cheaper imports. Today, there are many existing literature on the topical issue of trade openness and growth of which some support the axiom that openness is directly correlated to greater economic growth with the main operational implication being that governments should dismantle the barriers to trade. The focal point of this research work is to identify the short comings and benefits of this argument as well as check the validity of this mainstream axiom I Nigeria in the presence of various internal and external shocks.
1.6 SIGNIFICANCE OF THE STUDY
The role of international trade in the developmental journey of an economy can not be over emphasized, especially with the current trend of globalization. Nigeria. Being part of the global village, is not left out of this world development. This research work is carried out to study how trade openness has influenced the performance of the Nigeria economy through output growth in the presence of other internal and external shocks. The findings of this research work transcend beyond mere academic brainstorming, but will be of immense benefit to federal agencies, policy makers, intellectual researcher and international trade think tanks that occasionally prescribe and suggest policy options to the government on trade related issues. It will also help the government to see the effectiveness of trade liberalization policy on the economic growth of the nation over the years. This research work will further serve as a guide and provide insight for future research on this topic and related field for students who are willing to improve it. It will also educate the public on various government policies as related to trade issues.
1.7 SCOPE AND LIMITATION F THE STUDY
This research work span through the period of 1970-2007 (38 years), and is within the geographical zone of Nigeria. Thus, it is a country-specific research. This research exercise, like every other research work, is really a rigorous one that consumes much time and energy especially in the area of data sourcing, data computation and modeling. This work is relatively limited base on time and financial constraints, data availability precision of data and data range, and methodology adopted which could further be verified by future research. Nevertheless, the researchers have properly organized the research so as to present dependable results which can aid effective policy making and implementation at least for the time being.
“Openness” refers to the degree of dependence of an economy on international trade and financial flows. Trade openness measures the international competitiveness of a country in the global marked. Thus, we may talk of trade openness and financial openness. Trade openness is often measured by the ratio of import to GDP or alternatively, the ratio of trade to GDP. It is now generally accepted that increase openness with respect to both trade and capital flows will be beneficial to a country. Increased openness facilities greater integration into global markets. Integration and globalization are beneficial to developing countries although there are also some potential risks. (Iyoha and Oriakhi, 2002). Trade openness is interpreted to include import and export taxes, as well as explicit non tariff distortions of trade or in varying degrees of broadness to cover such matters as exchange-rate policies, domestic taxes and subsides, competition and other regulatory policies, education policies, the nature of the legal system, the form of government, and the general nature of institution and culture (Baldwin, 2002).
2.1 THEORETICAL LITERATURE
The issue of whether trade and increased openness would lead to higher rate of economic growth is an age-old question which has sustained debate between pro-traders and protectionists over the years from classicalists like Adam Smith, John Stuart mill, to John Maynard Keynes, Raul Prebisch, Hans Singer, Paul Krugman and many others. Theorists from both theses have influenced policy many countries and at various stage of development there has also been a huge policy debate about what constitute “good” and “bad” policies for these countries, especially the developing countries such as Nigeria should these countries completely open up to international trade? Or should they instead, at least temporality, protect some or all of their industries from the world marked forces? Form arguments have been developed pro and con of both theses. These arguments were discussed extensively by Maskus (1998) thus:
Argument One: Economies Will Grow Faster If They Protect Domestic Industry From Import Competition
This is a general statement of the infant-industry hypothesis”, which states that manufacturing sectors in underdeveloped economics must be sheltered from competition in order to have the incentive to invest capital, learn how to produce goods efficiently, take advantage of scale economies through large scale production, and develop innovative or distinctive products that can be sold on world markets. The broadest application of the infant-industry argument for world markets. The broadest application of the infant-industry argument for isolation from global markets emerged in the widespread use of import substitution policies in developing countries.
A policy of import substitution for industrialization purpose (ISI) involves extensively controlling virtually all components of the economy in order to direct resources into manufacturing. It is an old idea, but its modern origins come from economists writing in the 1950s and 1960s (Arthur Lewis, Raul Prebish, Hans singer, Gunnar Myrdal., and others), who claimed that developing economies faced two fundamental problems. First, their status as primary-commodity exporters left them vulnerable to world swings in commodity prices (e.g. oil, sugar, tin, copper, etc) and also that over a long-run, commodity prices would decline relative to manufacturing prices and costs of new technologies. Second, because developing countries have high population growth rates and abundant labor supplies, it would be difficult to absorb workers into primary production. Rather than waiting for comparative advantage to push resources into labor-intensive manufacturing, it would be better to force industrialization through ISI policies. Such programmes become common in the 1950s throughout Latin America, Africa, the Middle East, South Asia and Southeast Asia; they are still much in evidence in many countries.
Policies imposed in a thorough ISI programme include the following:
· Escalating tariffs, or tariff rates that rise with the stage of processing. Thus, low tariffs on primary goods, medium tariffs on industrial inputs and machinery, and high tariffs on final goods, particularly consumers goods such as food products, clothing, cosmetics, automobiles, and so on. Such tariff structures established very high effective rates of protection for final goods, meaning that auto factories and so on were strongly protected.
· Considerable taxes on production of primary commodities in other to push labor out of the country’s side and into the cities for developing manufacturing. Such taxes include tariffs on imported fertilizer price ceilings at very low rates for crops, export taxes on farm goods, and so on. For these reason ERPs in agriculture were often strongly negative, vastly reducing output and productivity in farming.
· Fixing exchange rates at expensive levels (i.e. “overvaluing” the domestic currency), again in order to discourage primary exports and production and also to reduce the cost of imported inputs for manufacturing sectors. Such exchange rates tended to generate large trade deficits, forcing governments to borrow from abroad and build up debt. It also required setting and controlling multiple exchange rates, so that capital and input transactions could take place at cheaper rates than goods imports in order to protect domestic industry.
· Extensive systems of quotas and licensing for imports and production.
· Rigorous controls on FDI coming into the country, requiring foreign firms to meet certain performance requirements. Also controls on imported technologies, with governments placing restrictions on costs of technology and under what terms it would be transferred to local firms.
· Extensive nationalization of industry to establish state-owned enterprises (SOEs) in key sectors, such as petroleum, steel, chemicals, construction, banking, and airlines. These “industry champions” received government subsides and were favored in the process of capital allocation, typically being allowed to borrow at very low rates from state banks (usually at negative real interest rates).
To some degree these policies successfully pushed industrialization, but rarely of an efficient kind. Developing countries are full of large manufacturing operations that operate at inefficiently low scales because market sizes are small and product quality is not good enough to penetrate export markets, which is a costly activity. These operations are partly supported by government subsidies, generating rested interests in keeping them going and opposing liberalization. Relative prices of goods are heavily distorted by the various subsidies, trade restrictions, and licenses. Other unintended effects include massive shifts of workers into the cities and worsened sanitation and health problems.
However, the question is whether such policies have limited growth. Evidently many other factors are at work. What seems clear is that such countries have not performed well in terms of acquiring and improving technologies, have lagged significantly behind in product innovation and adaptation, have inefficient and distorted agricultural and manufacturing sectors, and have not performed well in building human capital, physical capital, and infrastructures. Some relevant figures are given later. Thus, these sources of growth have likely been limited in countries pursing ISI program.
ARGUMENT TWO: COUNTRIES WILL GROW FASTER IF THEY ARE OPEN TO INTERNATIONAL COMPETITION
This is the basic hope underlying trade-reform programmes that involve extensive liberalization of trade and investment barriers, unification of tariff rates and domestic tax rate, removal of consumption and production subsidies, and deregulation of industry and privatization of state owned enterprises. It is the essential philosophy behind World Bank loans to facilitate restructuring and IMF lending packages that require microeconomic structural reforms. It is also a very old idea (going back to Adam Smith and David Ricardo at least) but its modern translation into trade liberalization largely began with the reforms in Chile in the 1970s advocated by the “Chicago School” of economists (e.g. Milton Friedman, George Stigler).
A somewhat different version of this approach is (to contrast it with ISI) called export promotion, which is the policy followed largely by East Asian and Western countries. These approaches are not necessarily liberal in the sense of free competition. There are many examples of sheltered and subsidized domestic firms or industrial groupings; much of this protection was designed to encourage infant industries to mature and export. However, the key component of export promotion programs is not to discourage exports, as is done under ISI programs. The basic policies under export promotion include the following.
· Properly valued exchange rates, meaning exchange rates that do not discriminate between imports and exports. This is accomplished either through flexible rates or pegged exchange rates that are allowed to move gradually to account for inflation differences between the country in question and major export markets. In this sense the exchange rate did not impose any tax on exports.
· Remove taxes on export production and, indeed make the tax and tariff systems as neutral as possible across sectors of production. Thus, while in most of these nations agricultural production was protected from import competition, in manufacturing there were relatively little discrimination across types of goods. It is for this reason that export- promotion policies are far closer to open trade policies than are ISI policies. There were certainly major exceptions to this rule in many export- promotion countries, however.
· Rather than rely largely on import protection to promote infant industries, some active forms of export promotion in manufacturing and high-tech sector were taken, including favorable allocation of loans and subsides and rebates of import tariff paid on imported industrial inputs.
· Recognizing that exporting is harder than cutting off import because export require improving levels of quality and considerable foreign marketing cost, East Asia firms have emphasized quality control and access to foreign technology on favourable terms. Government have supported this by ensuring strong public educational effort, investments in infrastructure for export, and technology transfer policies that attempted to force inward technology flows at cheap price.
Recent problems in some countries (especially Asian countries) indicate that while export promotion strategies may have contributed to growth, they ultimately cause serious problems of over production (excess capacity) relative to the economy’s ability to consume commodities. (Maskus, 1998).
The World Bank favors lifting the protectionist measures that have locked low income countries out of rich- country export market infact most international bodies (WTO,IMF World Bank etc) strongly support the case for trade openness and financial liberalization when setting up programmes for developing countries or when multilateral meetings occur. Some of the arguments put forward in favor of increased openness to trade include the following:
· Specialization: Gains from specialization in the good in which the country has a comparative advantage such as productivity gains, lower costs of production etc.
· Variety: Greater variety of goods available to consumers thus increasing the consumer surplus and satisfying the consumers “demand of difference”.
· Increasing Returns: Economies of scale justify any market enlargement. However, conclusions are quite ambiguous. For instance the gain is by large dependent of the process of firms’ issue. A fixed market structure inhibits such gains in the many firms complete specialization scheme of monopolistic competition. In the same way, imposing consumers to buy a greater quantity of domestic products can be optimal. Domestic firms increase their output and achieve economies of scale, while the variety is not reduced. Notwithstanding such argument economies of scale are generally referred to as a key objective of integration policies.
· Pro-competitive effect: When an economy is open, there will be more intense competition which obliges local firms to operate more efficiently than under protection. There will also be drive for innovation and efficiency in production in a smaller of goods. The country Can thus compete internationally.
· Positive Externality: The technology is spread over the boundaries through trade and open countries benefit a better access to a world-wide basket of technology. Also, there will be Adoption of sound policies to make sure the country is attractive to investors: trade openness acts as a watch dog for politicians as bad economic performances are blamed on them. Good governance should thus be fostered.
On the other hand, some arguments were put forward by protectionist against trade openness Apoteker and Crozet (2003) have put forward five reasons that can at least under line the potential risks in opened trade.
· Fluidity: All products do not have the same fluidity, meaning that some may be easily relocated while some others are stickier and cannot be as easily moved.
· Multiple Comparative Advantages: As many countries with similar resources are opening up to trade, they bring at the same time their same comparative advantage on the market. This will create an excess supply of that product and its world price will decrease, thus harming all the providers.
· Instability as regards Financial Volatility: Implementing financial liberalization implies allowing financial flows to freely move in or out of a country. However, in a country which lacks political credibility or monetary strength and power, capital mobility and volatility can make economic policies useless, thus preventing a country from using fiscal or monetary tools to try to solve domestic economic problems. This means greater dependence on the international environment.
· Investor Size versus Market Size: If concentration on a small market is high, the issue of market efficiency becomes critical. Indeed if one of the large and few investors on a small market withdraw its funds, it can threaten the whole market equilibrium, and even create panic among other investors without any fundamental” reasons behind it.
· Time Frame: A country’s development process is a long-term one, while financial investors usually have a short-term approach. Thus there are potential conflict of interest between public authorities and private investors/companies, which can be harmful for development goals.
The unananimous agreement on the beneficial effects on growth and development of trade liberalization goes back to the emergence of the Washington consensus in the early 1980s. The consensus emerged in response to economic crisis affecting most developing countries at the time, triggered by the debt crisis. Nonetheless long-term economic growth is generally seen as being dependent on openness to trade. But, literature on trade theory and policy has since the time of Adam Smith debated whether openness and trade liberalization provide the necessary ingredient for economic growth (miller and Upadhya, 2000). Thus, in order to effectively understand the relationship between trade openness and output growth we need to review and understudy the trade theory, the theory of customs union and free trade areas and models of exported growth.
THEORY OF TRADE
The doctrine that trade enhances welfare and growth has a long and distinguished ancestry dating back to Adam Smith (1723-90). In his famous book, and inquiry into nature and causes of the wealth of nations (1776), Smith stressed the importance of trade as a vent for surplus production and as a means of widening the market thereby improving the division of labor and the level of productivity. He assert that “between whatever places foreign trade is carried on, they all of them derive two distinct benefits from it. It carries the surplus part of the produce of their land and labour for which there is no demand among them, and brings back in return something else for which there is a demand. It gives value to their superfluities, by exchanging them for something else, which may satisfy part of their wants and increase their enjoyments.
By means of it, the narrowness of the labour market does not hinder the division of labour in any particular branch of art or manufacture from being carried to the highest perfection. By opening a more extensive market for whatever part of the produce of their labour may exceed the home consumption, it encourages them to improve its productive powers and to augment its annual produce to the utmost, and thereby to increase the real revenue of wealth and society”. (Thirl Wall, 2000). We may summarize the absolute advantage trade theory of Adam Smith, thus, countries should specialize in and export those commodities in which they had an absolute advantage and should import those commodities in which the trading partner had an absolute advantage. That is to say, each country should export those commodities it produced more efficiently because the absolute labour required per unit was less than that of the prospective trading partners. (Appleyard and Field, 1998).
In the 19th century, the Smithian trade theory generated a lot of arguments. This led to David Ricardo (1772-1823) to develop the theory of comparative advantage and showed rigorously in his principles of political economy and taxation (1817) that on the assumptions of perfect competition and the full employment of resources, countries can reap welfare gains by specializing in the production of those goods with the lowest opportunity over domestic demand, provided that the international rate of exchange between commodities lies between the domestic opportunity cost ratios. These are essentially static gains that arise from the reallocation of resources from one sector to another as increased specialization, based on comparative advantage, takes place. These are the trade creation gains that arise within customs to trade are removed between members, but the gains are once-for-all. Once the tariff barriers have been removed, and no further reallocation takes place, the static gains are exhausted. The static gains from trade stem from the basic fact that countries are differently endowed with resources and because of this the opportunity cost of producing products varies from country to country. Opportunity cost is measured by the marginal rate of transformation between one good and another, as given by the slope of the production possibility curve; that is, by how much one good has to be sacrificed in order to produce another. The law of comparative advantage states that countries will benefit if they specialize in the production of those goods for which the opportunity cost is low and exchange those goods for other goods, the opportunity cost of which is higher. That is to say, the static gains from trade are measured by the resource gains to be obtained by exporting to obtain imports more cheaply in terms of resources given up, compared to producing the goods oneself.
In other words, the static gains from trade are measured by the excess cost of import substitution, by what is saved by not producing the imported good domestically. The resource gains can then be used in a variety of ways including increased domestic consumption of both goods (Thirl Wall, 2000).
On the other hand, the dynamic gains from trade continually shift outwards the whole production possibility frontier of countries if trade is associated with more investment and faster productivity growth based on scale economies, learning by doing and the acquisition of new knowledge from abroad, particular through foreign direct investment. The essence of dynamic gains is that the shift outwards the whole production possibility frontier by augmenting the availability of resources for production through increasing the productivity of resources and increasing their quantity. One of the major dynamic benefits of trade is that export markets widen the total market for a country’s producers. If production is subject to increasing returns, export growth becomes a continual source of productivity growth. There is also a close connection between increasing returns and the accumulation of capital. For a small country with no trade there is very little scope for large scale investment in advanced capital equipment; specialization is limited by the extent of the market. But if a poor country can trade, there is some prospect of industrialization and of dispensing with traditional methods of production. It is the dynamic gains from trade that are focused on in modern trade theory such as the Heckscher-Ohlin trade theory.
2.1.2 THEORY OF CUSTOMS UNIONS AND FREE TRADE AREAS
Since the end of the World War II, there had been several attempts to promote trade through the creation of international and regional trade agreements in the form of customs unions and free trade areas. Free trade area is a form of economic union in which all members of the group remove tariffs on each others products, while at the same time each member retain its independence in establishing trading policies with non-members.
In other words, the members of a free trade area can maintain individual tariffs and other trade barriers on the outside world. That is to say, in a free trade area, barriers to trade are brought down within the area, but there is no common external tariff. Also, free trade areas create trade, but the extent of trade diversion is likely to be much less, with the presumption that on narrow economic grounds free trade areas are superior.
On the other hand, a customs union is a form of economic integration in which all tariffs are removed between members and the group adopts a common external commercial policy toward non-members. Furthermore, the group acts as one body in the negotiation of all trade agreements with non-members. The existence of the common external tariff takes away the possibility of transshipment by non-members. Customs unions create trade, but also divert it from lower cost suppliers to higher cost suppliers within the union. Thus, the question is whether the benefits of trade creation exceed the costs of trade diversion.
Apart from trade creation and trade diversion, customs unions may also have other important effects associated with the enlargement of the market which are neglected by the static analysis. Firstly, the larger market may generate economies of scale. Secondly, integration is likely to promote increased competition which is likely to affect favorably prices and costs, and the growth of output. Thirdly, the widening of markets within a customs union is likely to attract international investment. Producers will prefer to produce within the union rather than face a common external tariff from outside. Finally if the world supply of output is not infinitely elastic, there are terms of trade effects to consider. Specifically if there is trade diversion, the world price of the good will fall, moving the terms of trade in favor of the customs union. This term of trade effect represents a welfare gain which may partly off set the welfare loss of trade diversion.
The two forms of economic integration discussed above are likely to be interior to a policy of unilateral tariff reductions, and therefore need to be justified on other economic or non-economic grounds. Thus, De Melo, Panagariya and Rodick (1993) suggest three channels through which regional integration could alter economic outcomes for the better.
Firstly, a regional trade agreement entails a larger political community which might lessen the scope for adverse discretionary actions by governments, and particular restrict the power of growth-retarding political interest groups, unless politically powerful lobbies can form alliances across countries.
Secondly, when a regional institution is set up ab nitio, better choices may be made than at the nation-state level, where policy-makers have to contend with existing institutions that accommodate factional interests. Thirdly, when participating countries have different economic institutions, policy-making at the regional levels will entail a compromise between those institutions and may lead to a superior outcome for at least some member countries. For example, if a customs union adopts as its common external tariff, the average tariff of the union, at least some members must benefit. Nevertheless, the World Bank is generally hostile to regional trading blocs, despite the potential political –cum-economic benefits, because of their relatively inward-looking nature. (Thirlwall, 2000).
2.1.3 MODELS OF EXPORT –LED GROWTH
The three main models of export-led growth that will be discussed are the neo classical supply –side model, the balance of payments constrained model which is also known as the Hicks super-multiplier model, and the virtuous circle model.
The Neoclassical Supply-Side Model: This model shows the relationship between exports and growth, and assumes that the export sector confers externalities on the non export sector, because of its exposure to foreign competition; and secondly that the export sector has a higher level of productivity than the non export sector. Thus, the share of exports in GDP, and the growth of exports, matter for overall growth performance. Feder (1983) was the first to prove a formal model of this type to explain the relation between export growth and output growth. The output of the export growth sector is assumed to be a function of labour and capital in the sector, the output of the non-export sector is assumed to be a function of labour, capital and the output of the export sector (so as to capture externalities), and the ratio of respective marginal factor productivities in the two sector is assumed to deviate from unity by a factor d. Feder tests the model taking a cross section of 19 semi industrialized countries and a larger sample of 31 countries over the period1964-73. He finds that there are substantial differences in productivity between the export and non-export sector are also evidence of externalities. The externalities conferred are part of the dynamic gains from trade which are associated with the transmission and diffusion of new ideas from abroad relating to both production techniques and efficient management practices. The cross-section work on exports and growth assumes, however that all countries in a sample conform to the same model, with the same intercept and coefficient parameters linking exports and growth. In practice, this is highly unlikely to be the case; and it transpires, in fact, that when time series studies are conducted for individual countries, the relation between exports and growth is much weaker.
BALANCE OF PAYMENTS CONSTRAINED GROWTH MODEL:
No country can grow faster than rate consistent with balance of payments equilibrium on current account in the long run, unless it can finance ever-growing deficits which, in general, it cannot. Ratios of deficit to GDP of more than 2%-3% to make the international financial markets nervous and all borrowing eventually have to be repaid. A country’s balance of payments equilibrium growth rate can be modeled by stating the balance of payments equilibrium condition specifying multiplicative (constant elasticity) import and export demand functions in which imports and exports are a function of domestic and foreign income, respectively, and of relative prices, and substituting these functions in the equilibrium conditions. Since imports are a function of domestic income, the model can be easily solved for the growth of income consistent with balance of payments equilibrium. Nureldin-Hussain (1995) applied this model to Africa to contrast the experience of slow growing African countries with the faster growing countries of Asia over the period 1970-90. He uses an extended model which also includes terms of trade effects and the effects of capital flows. The major explanation of the difference in growth rates between Africa and Asia turns out to be the difference in the growth of exports. He finds that the average growth of the African countries, excluding oil exporters, was 3.4 percent per annum, and of the Asian countries 6.6 percent. The contribution of export growth in Africa was 1.99 percentage points and in Asia 5.91 percentage points.
Differences in capital flows and terms of trade movements made only a minor contribution to growth rate differences. Thus, he concluded that exports are unique as a growth inducing force from the demand side because it is the only component of demand that provides foreign exchange to pay for the import requirements for growth. In this sense, it allows all other components of demand to grow faster in a way that consumption-led growth or investment-led growth does not.
Virtuous Circle Models of Export-Led Growth
There is need to recognize the fact that export and growth may be interrelated in a cumulative process. This raises the questions of casualty; but more importantly, such model provide and explanation of why growth and development through trade tends to be concentrated in particular areas of the world, while other regions and countries have been left behind. These models provide a challenge to both orthodox growth theory and trade theory which predict the long run convergence of living standards across the world. A simple cumulative model, driven by exports as the major component of autonomous demand, is to assume that (i) output growth is a function of export growth, (ii)export growth is a function of price competitiveness and foreign income growth, (iii) price competitiveness is a function of wage growth and productivity growth, and (iv) productivity growth is a function of output growth (this is referred to as verdoorn law which works through static and dynamic returns to scale, including learning by doing). It is this induced productivity growth that makes the model circular and cumulative’ since if fast output growth (caused by export growth) induces faster productivity growth this makes goods more competitive and therefore induces faster export growth. The verdoorn relation not only makes the model ‘circular and cumulative’; but also gives rise to the possibility that once an economy obtains a growth advantage it will tend to keep it. Suppose, for example, that an economy obtains an advantage in the production of goods with a high income elasticity of demand in world markets, such as high technology goods, which raises its growth rate above other countries. Through the verdoorn effect, productivity growth will be higher and the economy will retain its competitive advantage in these goods, making it difficult, without protection or exceptional industrial enterprise, to establish the same commodities.
In such a cumulative model, it is the difference between the income elasticity characteristics of exports (and imports, if balance of payments equilibrium is a requirement as argued earlier) that is the essence of divergence between industrial and agricultural economies, or between centre and periphery. (Thirl Wall, 2000).
From the ongoing, we can conclude that trade liberalization does not necessarily imply faster export growth, but impractical the two appear to be highly correlated. Impact of the liberalization on economic growth probably works mainly through improving efficiency and stimulating exports which have powerful effects on both supply and demand within an economy. There are several different measure of trade liberalization or trade orientation, and all studies seem to show a positive effect of liberalization on economic performance. Likewise there are several different studies of the relation between exports and growth and the evidence seem over whelming that the two are highly correlated in a causal sense, but the relative importance of the precise mechanisms by which export growth impacts on economic growth are not always easy to discern or qualify.
2.2 EMPIRICAL LITERATURE
The relationship between trade openness and growth is a highly debated topic in the growth and development literature, yet this issue is far from being resolved. There is a long history of research, both theoretical and empirical, that provides at least an answer to the question: does openness to trade result in the growth of output (say, GDP)? But currently there is no consensus, either empirically to theoretically, on the nature of the relationship between trade openness and output growth. In fact, this is because the mechanisms behind it are not well understood. The existing empirical literature however does not provide clear evidence on relationship between trade openness and growth. Many studies provide evidence that increasing openness has a positive effect on GDP growth. On the other hand some studies report that it is difficult to find robust positive relationships or even that there is negative relationship between openness and growth. Some studies, among other Rodriguez and Rodrik (1999) and Rodriguez (2006), critically argue that trade policy variables are mostly uncorrelated with growth, while the trade shares can correlate with income levels and growth rates. But the complexity of links of causality and endogeneity among trade shares, growth and other sources of growth make a difficulty to define a strong effect of openness on economic growth. Theoretical growth studies suggest very complex and different relationships between openness and growth and the empirical evidence is not unambiguous. The growth theory supposes that “a country’s openness to world trade improves domestic technology, and hence an open economy grows faster than a closed economy through its impact on technological enhancement” (Jin, 2006). Harrison (1996) asserted that openness to trade provides access to imported inputs, which embody new technology, increases the size of the market faced by the domestic producers, which raises the return to innovation, and facilitates a country’s specialization in research intensive production.
In line with potential dynamic gains of trade openness, most early empirical studies have examined a set of trade openness measures and with their correlation with each other and with economic growth and found a clear positive link. For example, Harrison (1996) looked at a number of openness indicators that turned out to have a positive ‘association’ with economic growth and produced evidence in support of bi-directional casualty between openness (trade share) and economic growth. Recent research, however, has questioned the robustness of the relationship. For instance, Harrison and Hanson (1999) show that the often quoted Sachs and Warner (1995) openness and growth link as claimed.
Rodriguez and Rodrik (1999) confirm the Harrison –Hanson critique and argued that much of the work to correlate trade openness and economic growth has been plagued with subjective and collinear measures of openness that, though positively related with economic growth, arrive at their conclusion through problematic econometric methodologies. Harrison (1996) and Pritchett (1996) show that the various measure of trade openness tend to be only weakly correlated and are often of the wrong sign.
In general, empirical studies suffer from a number of short comings, and as a result they have not resolved the questions surrounding the correlation between openness and growth. Baldwin (2000) offers explanation for the differences among researchers of the openness growth nexus. According to him, while econometric analyses based on quantitative data are limited by the scope and comparability of available quantitative data, differences in what investigators regard as appropriate econometric models and tests for sensitivity of the results to alternative specifications that may be based in part on the personal policy predilections of authors and can also result in significant differences in the conclusions reached under such quantitative approaches. If these studies used measures that were even slightly correlated, then empirical literature together could be taken as proof of a positive relation between openness and growth. Baliamoune-lutz and Ndikumana (2007) observed that, from a methodological stand point, the weak link between trade liberalization and growth may be attributed to measurement imperfections: the indicators used in empirical analysis may not capture the true essence of openness. Indeed, due to lack of data on indicators of trade openness as a policy empirical studies (as this one does) resort to measures of trade outcomes i.e. trade volume, as proxies for trade openness it is assumed that positive trade outcomes are an indication of a policy environment that is at least not anti-trade. Moreover, a high trade volume indicates exposure to international markets with the associated benefits (e.g. technological transfer) which openness policies seek to achieve. Thus, to some extent trade outcomes do carry some indication of the effects of trade liberalization. Nonetheless, results from analyses using trade volume as a measure of trade openness have to be interpreted consciously. Indeed, variations in the volume of trade do not always reflect actual government policies that promote or hinder trade. For instance, fluctuations in commodity prices result in changes in trade flows even in the absence of shifts in trade policy.
The weak empirical evidence on the link-between trade liberalization and growth can also be due to problems of misspecification. In particular, the effects of trade liberalization may materialize only with a lag. In the short run, liberalization may have negative effects, especially by undermining domestic production because of competitive import, retarding growth (Mukhopadhyay 1999). Hence, to the extent that these negative short-run effects and the expected delayed positive effects occur consecutively, growth would exhibit a J-curve of response to trade openness (Greenaway etal 2002). Therefore, empirical studies may yield inconclusive and even misreading results if these dynamic and counter balancing effects are not fully taken into account.
Another explanation relates to the structure of trade. Whether a country benefits from trade liberalization or not in terms of growth depends on the composition of trade. Mazumdar (1996) hypothesized that the composition of trade determines the strength of the engine of growth.” Indeed lower and Van Den Berg (2003) final evidence supporting the view that countries that import capital goods and export consumer goods growth faster than those that export capital goods. The evidence suggests that African countries and developing countries in general would benefit from trade most by promoting exports of labour-intensive goods and services while encouraging imports of capital goods. (Lopez 1991). This implies that the current export boom which is driven by capital-intensive growth that is sustainable, especially because of the low gains in employment creation and limited spill over effects on non-oil sectors.
Dollar (1992) brought an important contribution to the trade and growth debate. The author defines openness as the combination of two diversions:
i. A low level of protection, hence of trade distortions and
ii. A stable real exchange rate so that incentives remain constant over time.
From that very definition, follow two measures openness: a trade distortion index, and a real exchange rate variability index. The distortion index measures the deviation from the law of one price after controlling for the impact of non-tradable. The variability index captures the variance of the real exchange rate. The author considers a sample of 95 countries over the period 1976 -1985 and regresses average per capital growth upon his openness indexes and the average investment rate. Both the distortion index and the variability index are significantly negatively correlated with growth and the investment rate comes out with a significantly positive coefficient.
Dow Rick (1994) tests whether trade openness affects output growth and /or investment. He considers a sample of 74 countries over the period 1960-1990. As openness indicator, the author considers the residuals of an OLS cross-country regression of the average trade intensity upon a constant and average population. In a second stage, the author runs cross-country OLS regressions of average per capita GDP growth upon the average investment rate, the initial GDP level and his openness indicator. The coefficient on openness is significant and positive. More over, dropping the investment rate considerably lowers the overall fit of the model but enhance the coefficient on openness, which according to the author “suggests that openness works partly through increased investment rates”.
In a third stage, the author computes decade averages for his variables and turns to panel data techniques, gauging that such techniques “enable some control for time invariant country-specific factors such as institutional arrangements that might be correlated with the explanatory variables”. The author uses labour productivity growth as dependent variable and estimates both fixed-effects and random-effects models. He reports that the coefficient on openness is still significant and positive, but its point estimate is much lower than in the OLS specification. In a fourth set of regressions, the author also considers growth in openness instead of openness itself.
The author interprets this as reflecting the fact that “static efficiency effects of trade liberalization are negligible for countries with well-developed markets”. Finally, in its conclusions, the author cautions that his results, showing the beneficial effects of increased openness, hold on average, but are not a universal truth, valid always and every where.
In particular, he stresses that “trade liberalization can indeed stimulate growth in the aggregate world economy. Whilst trade may have such positive effects for some countries, it may conversely lock in other countries into a pattern of specialization in low-skill, low-growth activities.”
Sachs and Warner (1995) brought a seminal contribution to that literature. Their central hypothesis is that some developing countries fail to grow rapidly enough as to converge because they are simply not open to trade. In their own wards: “convergence can be achieved by all countries, even those with low initial level of skill, as long as they are open and integrated in the world economy”. To check their hypothesis, the author first carefully, build and discuss an openness measure. Building upon a sample of 135 countries over the period 1970-1990, they construct and openness dummy variable that is zero if any of the 5 following conditions is true:
· Non-tariff barriers covering 40% or more of trade
· Average tariff rate above 40%
· Black market premium above 20%
· The economy is ruled by a socialist system, or
· There is a state monopoly on exports.
Otherwise, if none of these 5 conditions is fulfilled, the openness dummy is one. The authors first divide their countries sample into open ones and closed ones, and show that closed countries have grown at about the same rate (essentially about 0.7% a year), no matter whether they are developed or not. By contrast, open developing countries have grown much faster than their developed counter parts (4.49% versus 2.29%). Going beyond these stylized facts the authors re-do the same regressions as in Barro (1991) and add their openness dummy to them without the dummy, the results are sensibly the same as in Barro (1991). After adding the openness dummy in the regresses list, it appears its coefficient is highly significant. The points estimates suggest that open economies grow on average 2.45% faster than closed ones.
Moreover, educational attainment variables become even less significant than in Barro (1991), which leads the authors to think that “….growth rate over this period was determined less by initial human capital levels than by policy choices”. They also address a specialization-related issue. Specifically, they test whether trade openness condemns raw materials exporters to non-industrialization and whether closed trade promotes industrial exports in the long run. To do this, they regress the change in the share of primary exports more rapidly from being primary-intensive to manufactures-intensive exporters. The difference in speed of adjustment is statistically significant”.
Harrison (1996) starts from the judgment that “it should be evident that no independent measures of so-called ‘openness’ is free from methodological problem”. Therefore, to make her point, she collects as many different openness indicators as she can, about 7 of them, and she checks the consistency of the results across all these indicators. She uses various samples, whose time spans range from 1960-1998 to 1978-1987,and the country coverage varies from 51 to 17.she first runs typical cross-country growth regressions. It appears that only one measure of openness out of 7, namely the black market premium, has a significant impact on growth. To explain this weak result the author argues that a pure cross-section specification, based upon long-run averages, is not an adequate one. Indeed, though the use of long run averages appears as the most natural way to capture the determinants of long-run growth, they may also hide significant variations in individual countries performances and policies over time. To test this idea, the author re-does her regressions using annual data for the same variables. She uses a panel fixed-effects specification to take into account unobserved country specific differences in growth rates. Results show a stronger link between openness and growth since 3 indicators become significant at the conventional 5% level. The author next argues that such a yearly frequency is too high if one is interested in long-run growth, since results may be affected by short-term conjectural, variations. She therefore considers a third- “intermediate”- specification, based on five-year averages and reports that, again 3 indicators come out with a significant coefficient. The message from these results, as the author states, is that “the choice of the time period for analysis is critical”. However, an interesting regularity appears across all specifications: When openness is significant; it is always in the sense that greater openness is associated with higher growth.
Edwards (1998) also uses an important number of openness indexes to investigate the trade and growth relationship. He considers a sample of 93 advanced and developing countries, and estimates a growth equation with a panel data random effects model. From that model, he computes factor shaves, which are then used to get TFP estimates. Concentrating on a cross-section of 1980s averages, TFP growth is finally regressed upon initial income level, initial human capital level, and no less than 9 openness indicators, each one of them in turn. The author reports that “in all but one of the 18 equations the estimated coefficient on the openness indicator has the expected sign and in the vast majority of cases it is significant”. Moreover, the coefficient on initial human capital is always significant and positive. Regarding the initial income level, the coefficient is always negative and in 16 cases out of 18, it is significant though very low, which can be interpreted as evidence in favor of conditional convergence. To summarize, the authors concludes that his results “are quite remarkable, suggesting with tremendous consistency that there is a significantly positive relationship between trade openness and growth”.
An important paper that is able to cast serious doubts about the consistency of the trade-growth relationship is the one by Rodriguez and Rodrik (1999). These authors consider a series of previous research results, among which Dollar (1998). Sachs and Warner (1995), and Edwards (1998). The re-do the computations in these papers, but slightly change the specifications (through the addition of some dummies, e.g.), add newly available data to the sample, or slightly change the estimation methods. They are able to demonstrate a fundamental lack of robustness of the results in the paper they reviewed.
Frankel and Romer (1999) claim that openness, as measured by the ratio of total trade to GDP, should not be used as explanatory variable in the growth regressions. The trade ratio, the authors argue, is endogenous, and needs to be instrumented. To construct their instrument, the authors first argue that “as the literature on the gravity model of trade demonstrates, geography is a powerful determinant of bilateral trade. And they claim this is also true for total trade. Moreover, geography is completely exogenous. Therefore, the authors consider a database of bilateral trade between 63 countries for 1985 and they regress bilateral trade upon purely geographical indicators. For each country, the fitted values of trade are aggregate over all partners, and this aggregate is finally turned into an “ideal” trade share that can be used as an instrument for the observed one. The authors then estimate growth equations for a cross-section of 150 countries in 1985. They report a substantial impact of trade openness on income growth: increasing the trade share by 1% should raise income by between 0.5% and 2%. These findings are robust to various changes in specifications. The results also suggest that, controlling for openness; larger countries tend to experience higher growth rates, which could simply reflect that citizens living in larger countries engage more in within country trade.
Baldwin and Sbergani (2000) argue that the reason why researchers failed to find a robust relationship between trade and openness is because that relationship is fundamentally non linear and non-monotonic. They raise the point that the fundamental engine of growth is human and physical accumulation, and that the link between capital accumulation and trade barriers is, in nearly all models, non linear and often even non-monotonic. They provide a formal 2x2x2 dynamic model with imperfect competition that gives rise to (i) all-shaped relationship between ad-valorem tariffs and growth and (ii) a bell-shaped relationship between specific tariffs and growth. This model is then confronted to the data, i.e. for a variety of openness indicators (actually, 10 of them are considered), a quadratic model is estimated. It turns out that, in this new specification, for 6 of the 10 proxies both the linear and the quadratic terms are significant individually. The authors conclude that: “allowing for non-linearity does have a big empirical impact”.
A number of other studies have looked at the relationship between average tariff rates and growth. Lee (1993), Harrison (1996) and Edwards (1998) found negative relationship between the tariff rates and growth. The studies of Edwards (1992), Sala-i- Martin (1997) and Clemens and Williamson (2001) conclude that the relationship is weak. Rodriguez and Rodrick (1999) tried to replicate the result of Edwards (1998) and found that average tariff rates had a positive and significant relationship with total factor productivity (TFP) growth for a sample of 43 countries over the period 1980-1990.
In a recent study Vanikkaya (2003) used a large number of openness measure for a cross-section of countries over the last three decades. His analysis found a significant positive correlation between trade shares and growth. However, this study observed that different measures of trade barriers are positively associated with growth in the less developed countries. In recent empirical studies, one or more of the following indicators of openness in the table below are used:
Trade dependency ratio
The ratio of exports and import to GDP
Growth rate of exports
The growth rate of exports over the specified period
A simple or trade-weighted average of tariff levels.
Collected Tariff Ratios
The ratio of tariff revenues to imports.
Coverage of Quantitative Restrictions
The percentage of goods covered by quantitative restrictions.
Black market premium
The black market premium for Foreign exchange, a proxy for the overall degree of external sector distortions.
Trade Bias Index
The extent to which policy increases the ratio of importable goods’ prices relative to exportable goods prices compared to the same ratio in world markets.
Sachs And Warner Index
A composite index that uses several trade-related indicators tariffs, quota coverage, black market premiums, social organization and the existence of export marketing boards.
Learner’s Openness Index
An index that estimates the difference between the actual trade flows and those that was expected from a theoretical trade model.
Table1: openness indicators.
(Rodriguez and Rodrik, 2000; Ogujiuba, Oji and Adenuga, 2004).
Gross man and Helpman (991) and Matsuyama (1992) provide theoretical models where a technological backward country specializes in a non-dynamic sector as result of openness, thus losing out from the benefits of increasing returns. Underlying this result, there is an imperfection in contracts or in financial markets that makes people obey a myopic notion of comparative advantage.
Dollar and Kraay (2004) and Loayza, Fajnzylber, and Calderon (2005) run growth regressions on panel data of large samples of countries. Both papers use openness indicators based on trade on trade volumes and control for their joint endogeneity and correlation with country-specific factors through GMM methods that involve taking differences of data and instruments. This implies that, although they continue to use cross –country data, these papers favors within-country changes as the main sources of relevant variation. Both papers conclude that opening the economy to international trade brings about significant growth improvements. Wacziarg and Welch (2003) arrive to a similar, though more nuanced, conclusion from a methodological different stand point. Using an event-study methodology –where the event is defined as the year of substantial trade policy liberalization--, they find that liberalizing countries tend to experience significantly higher volume of trade, investment rates, and most importantly, growth rates. However, in an examination of 13 country-case studies Wacziarg and Welch find noticeable heterogeneity in the growth response to trade liberalization. Although their small sample does not allow for definite conclusions, it appears that the growth response after liberalization is positively related to conditions of political stability.
Also, various empirical literatures offer some examples of non-linear specifications considering interaction effects. On the related topic of foreign direct investment, Borensztein, De Gregorio and Lee (1998) find that the growth effect of FDI is significantly positive only when the host country has, respectively, sufficiently high human capital and financial depth. Specifically in the analysis of grow effects of trade openness, an important antecedent of our work is the empirical study by Bolaky and Freund (2004). Using cross-country regressions in levels and changes of per capita GDP and controlling for simultaneity via external instruments, they find that trade opening promotes economic growth only in country’s that are not excessively regulated. They argue that in highly regulated countries, growth does not accompany trade openness because resources are prevented from flowing to the most productive sectors and firms, and trade is likely to occur in goods where comparative advantage is actually missing.
Calderon, Loayza, and Schmidt –Hebbel (2004) interact in their panel growth regressions a measure of openness (volume of trade /GDP) with linear and quadratic terms of GDP per capita, which they regard as proxy for overall development. They find that the growth effect of trade opening is nearly zero for low levels of per capita GDP, increases at a decreasing rate as income rises, and reaches a maximum at high levels of income.
Chang, Kaltani and Loayza (2005) study how the effect of trade openness on economic growth depends on complementary reforms that help a country take advantage of international competition. They presented some panel evidence on how the growth effect of openness depends on a variety of structural characteristics. They use non-linear growth regression specification that interacts a proxy of trade openness with proxies of educational investment, financial depth, inflation, stabilization, public infrastructure, governance, labour-market flexibility, ease of firm entry, and ease of firm exit. They find that the growth effects of openness are positive and economically significant if certain complementary reforms are undertaken.
Giles and Stroomer (2005) develop flexible techniques for measuring the speed of output convergence between countries when such convergence may be of an unknown non-linear form. They then calculate these convergence speeds for various countries, in terms of half lives, using a time-series data-set for 88 countries. These calculations are based on both non parametric kernel regression and ‘fuzzy’ regression and the results are compared with more restrictive estimates based on the assumption of linear convergence. The calculated half-lives are regressed, again in various flexible ways, on cross-section data for the degree of openness to trade. They find evidence that favors the hypothesis that increased trade openness is associated with a faster rate of convergence in output between countries.
Joffrey (2003) in his work, tries to clarify a number of issues related to the “trade openness and growth debate”. He considers a number of sector specialization indicators and examine whether they indeed affect the link between openness and growth. Using both cross-section and panel data techniques, he finds that both its pattern are likely to affect significantly the link between openness and growth.
On research studies that relate to Africa and Nigeria in specific, Sarkar (2007) examines the relationship between openness (trade-GDP ratio) and growth. The cross-country panel data analysis of a sample 51 countries of the South during 1981-2002 shows that for only 11 rich and highly trade-dependent countries a higher real growth is associated with a higher trade share. Time series study of individual country experiences shows that the majority of the countries covered in the sample including the East Asian countries experienced no positive long-term relationship between openness and growth during 1961-2002. He finds that the experience of various regions and groups shows that only the middle income group exhibited a positive long-term relationship.
Also, Baliamoune-Lutz and Ndikumana (2007) explore the argument that one of the causes of the limited growth effects of trade openness in Africa maybe the weakness of institutions. They also control for several major factors and, in particular, for export diversification, using a newly developed data set on Africa. Results from Arellano-Bond GMM estimations on panel data from African countries show that institutions play an important role in enhancing the growth effects of trade. They find that the joint effect of institutions and trade has U-shape, suggesting that as openness to trade reaches high levels, institution play a critical role in harnessing the trade-led engine of growth. The results from this paper are informative about the missing link between trade liberalization and growth in the case of African countries. Likewise, Ogujiuba, Oji and Adenuga (2004) test the validity of trade openness for Nigeria’s long-run growth using a co-integration approach. They preferred the VAR approach for some reasons and their econometric results show that there is no significant relationship between openness and economic growth, and that unbridled openness could have deleterious implications for growth of local industries, the real sector and government revenue.
Moreover, Addison and Wodon (2007) study the macroeconomic volatility, private investment growth, and poverty in Nigeria. Using cross-sectional data for 87 countries, they show that real per-capita growth over the period 1980 -1994 was a function of productivity growth and investment rates, both of which were negatively affected by volatility (in terms of trade, real exchange rate, and public investments). When comparing Nigeria to high growth nations, they find that most of the growth differential can be attributed to Nigeria’s higher macroeconomic volatility. Simulations suggest that if Nigeria had lower levels of volatility and better macro- economic policies, poverty would have been much lower than observed.
Nwafor (unpublished) examines the effects reduction of import tariffs will have on poverty in Nigeria, using information on Nigeria’s past experience with trade liberalization he examined the possible impacts on the economy with a view to making the reductions pro-poor.
Kandiero and Chitiga (2003) investigate the impact of openness to trade on the FDI inflow to Africa. Specifically, in addition to economy wide trade openness, they analyze the impact on FDI of openness and manufactured goods, primary commodities and services. The empirical work is conducted using cross-country data comprising of African countries observed over four periods: 1980-1985, 1985-1990, 1990-1995, and 1995-2001, they find that FDI to GDP ratio responds well to increased openness in the whole economy and in the services sector in particular.
Finally, Njikam, Binam and Tachi (2006) assess the factors behind differences, in total factor productivity (TFP) across sub-Sahara Africa (SSA) countries over the period 1965-2000. The cross-section, fixed effects using annual data, fixed-effects using data in 3-year averages as well as the seemingly unrelated regression (SUR) results show that (i) openness to world trade is conducive to TFP in SSA region only if issues related to supply conditions such as poor transport and communication infrastructure, erratic supply of electric energy. Corruption and bad governance, insufficient education of the labour force etc are adequately addressed, (ii) physical capital accumulation is important for TFP, (iii) the size of the financial sector mattes for TFP, in some SSA countries and negative for TFP in other SSA countries.
2.3 LIMITATION OF PREVIOUS STUDIES
The literatures of previous studies are plagued with a lot of problems. First of all, it is worthwhile to note that the theoretical growth literature has given more attention to the relationship between trade policies and growth rather than the relationship between trade volumes and growth. Therefore the conclusion about the relationship between trade barriers and growth cannot be directly applied to the effects of changes in trade volumes on growth. There was also no consensus on the nature of the relationship and nature of linear association (correlation) between openness and growth. Likewise, there is no generally accepted measure of openness indicators as it suit and please the researcher(s). Moreover, many of the existing empirical literature are not country-specific, that is they deal with cross-sectional analysis, thus they did not provide for differential in nature and structure of various economies. Hence, developing countries like Nigeria are recommended policies which are based on research conducted for industrially advanced countries or even mixture of both.
3.1 ANALYTICAL FRAMEWORK
The primary aim of every economic research is to arrive at a conjunction of economic theory, actual measurement using the theory and techniques of statistical inferences as the matching bridge (Haavelmo, 1994). The economic theory makes statement or postulates hypothesis that are mostly quantitative (and some cases qualitative) in nature and as such, it is the choice of the modeler or the researcher to validate these hypothesis using appropriate models in line with current development and betting method of estimation and inference.
Economic theory and some empirical research argue that openness (trade or financial) will definitely increase output growth while others opened that the relationship between the two is ambiguous. In order to contribute empirically to this argument, this study will employ econometric method as the research technique. The choice of method is necessitated by the nature of the study which in this case is an analysis of relationship among variables.
3.2 MODEL SPECIFICATION
An economic model is a representation of the basic features of an economic phenomenon; it is an abstraction of the real world (Fonta, Ichoku and Anumudu, 2003). The specification of a model is based on the available information relevant to the study in question. This is to say, the formulation of an economic model is dependent on available information on the study as embedded in standard economic theory and other major empirical works, or else, the model would be theoretical. Two models are postulated in this research work; the first is a non-monotonic model to capture the first and second objective of the study, while the second is an analysis of covariance (ANCOVA) model. The functional form of these models can be specified as follows:
RGDPt = (TPNt,TPNt2, RERt, RIRt, UNEMPt, TREND)…..(i)
RGPt = f (DUMt, TREND, (DUMt*, TREND))…….(ii)
The mathematical form of the model can be expressed as:
RGDPt: ao + a1TPNt + a2TPNt2 + a3RERt + a4RIRt +a5UNEMPt + a6TREND
RGDPt = bo + biDUMt + b2TREND + b3(DUM*t TREND) -------------------------------------------------------------------------(iv)
But equations (iii) and (iv) above are exact or deterministic in nature. In order to allow for the inexact relationship among the variables as in the case of most economic variables stochastic error term “μt” is added to both equations. Thus, we can express the econometric form of the models as:
RGDPt = ao + a1TPNt + a2TPn2t + a3RERt + a4RIRt + a5UNEMPt + a6TREND + μit -------------------------------------(v)
RGDPt = β0 + β1DUMt + β2TREND + β3(DUM*t TREND) +µ2t ------------------------------------------------------------------(vi)
Where RGDP = Real Gross Domestic Product which is a proxy for the real output of the economy.
TPN = The Degree of openness measured as trade – GDP
ratio i.e. (import + Export)/GDP
TPN2 = Real exchange rate
RIR = Real Interest Rate
UNEMP = Unemployment Rate
DUM = O for pre-SAP period observations
I for post –SAP period observations
TREND = The chronological arrangement of time
µ = The stochastic error term
In order to properly estimate the parameters of the postulated models, we rescale the dependent variable by logging it, thus, transforming them into a log-line models as follow:
LOG (RGDPt) = ao+ a1TPNt + a2TPN2t +a3RERt + a4RIRt + a5UNEMPt +a6TREND + µit -------------------- --------------(viii)
LOG (RGDPt) = β0+β1DUMt+β2TREND +β3 (DUM*tTREND) +µ2t -------------------------------------------------(viii)
Also, in order to avoid a spurious regression, we subject each of the variables used to unit root (or stationary) test so as to determine their orders of integration, since unit root problem is a common feature of most time-series data.
3.2.1 TEST OF STATIONARY
A stochastic process is said to stationary if its mean and variance are constant overtime and the value are auto-covariance between the two time period depends only on the distance or lay between the two time periods and not the actual time at which the covariance is computed (Gujarati, 2003). In other word, a stationary stochastic process is one with constant mean, variance and covariance. Hence, stationarity test is carried out to verify whether a time series is stationary or time-invariant so as to avoid a spurious regression.
The Phillips-perron (pp) unit roof test will be employed. The choice of this test is to correct for some anomalies associated with the conventional Augmented Dickey-Fuller (ADF) test. The Phillips-perron test use non-parametric statistical methods to take care of the serial correlation in the error terms without adding lagged difference terms. This test is specified thus:
∆Yt =+a∆Yt-1+ μt
Where ∆ = difference operator
Yt = Time series
μt =Pure white noise.
Under the null hypothesis that a = 1 for stationarity, we use the PP test statistics to verify the presence of unit root in the series.
3.2.2 TEST OF COINTEGRATION
Economically, two (or more) variables will be co integrated if they have a long term, or equilibrium, relationship between (or among) them (Gujarati, 2003).
Individual time – series in a model may be spurious but their linear combination may not. This is the purpose of co-integration test.
The augmented Engle-Granger (AEG) test will be employed to validate this hypothesis. This hypothesis is of two stages:
· We will run the regression of equation (vii) and generate the residual.
· The residual generated to unit root test.
If the generated residual is stationary at level form or integrated of order zero i.e. 1(0), then the variables of the model are co-integrated. The AEG test is specified as:
∆mt = mt -1-+ai∑ ∆mt-1 +ℓt
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