Trade Liberalisation, Financial Development and Economic Growth: Evidence from Pakistan ( )

Transcription

1 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan ) Rao Muhammad Aif, Abida Jadoon, Khalid Zaman, Aisha Ismail, Rabia Seemab, Deparmen of Managemen Sciences, COMSATS Insiue of Informaion Technology, Abboabad, Pakisan Absrac This sudy invesigaes he impac of financial developmen and rade openness on GDP growh in Pakisan using annual daa over he period The analysis is based on he bound esing approach of co-inegraion advanced by Pesaran e al (2). The empirical resuls confirm he validiy of rade led growh and financial led growh hypohesis in Pakisan. A co-inegraed relaionship beween economic growh, rade openness and financial developmen was noiced in boh he long-run and shor-runs. Furher analysis showed ha rade openness and financial developmen Granger-cause economic growh in he period of sudy. Keywords Trade Openness; M2/GDP; Economic Growh; ARDL; Coinegraion; Pakisan. Inroducion The correlaion beween rade openness, financial developmen and growh has been well documened in lieraure. I has been assered ha financial developmen and rade openness policies reduce he disorions in he producion process and posiively influence GDP growh. This argumen is empirically proved because he counries wih highly developed financial secor and open rade policies have shown greaer GDP growh rae as compare o he counries who have resricive financial and rade policies. Several sudies have been conduced in order he find ou he effeciveness of rade liberalisaions which have a posiive impac on economic growh [see, Mckinnon (973), Shaw(973), Jin (2), Fry (995, 997) Levine (997) Darra, (999) and World Bank (989)]. While Bhagwai (988), Lee (993); Krueger (998) and Fry (995, 997) concludes ha he rade liberalisaion and financial developmen boh have significan and posiive relaionship wih growh. Oher sudies i.e., Barro (99) and Lucas (988) highlighed growh effecs of financial liberalisaion and rade openness by he use of he new growh heory. Similarly, Rivera- Baiz (99) and King and Levine (993) examined ha boh rade and financial liberalisaion along wih invesmen in human as well as physical capial augmen GDP growh. The sudies by Bencivenga and Smih (99) and De Gregorio and Guidoi (995) sugges ha financial secor expansion effecively convers savings o invesmen opporuniies and improves corporae governance, Whereas Greenwood and Jovanovic (99) and Levine (24) furher added ha financial deepening improves specialisaion and reduces informaion and ransacion coss. Aziz and Duenwald (22) sudied he relaionship beween growh and financial developmen in China and found ha financial developmen can influence growh hrough khalidzaman@cii.ne.pk Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 3

2 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 invesmen, rade liberalisaion and privae savings. Ansari (22) furher added ha financial liberalisaions can conribue o economic growh of a counry in he following manners: (i) financial markes encourages he small savers o pool funds (ii) i can encourage saving by providing a wider range of saving drives., (iii) As financial developmen increases he saving rae herefore i leads o efficien allocaion of capial, (iv) financial secor developmen redirec he credi from slow growing /less efficien secor of fas growing/efficien secor, (v) financial developmen somewha enables he financial insiuions o manage he problem of adverse selecion in credi marke,(vi) financial developmen promoes specialisaion,echnological developmen in producion, as well as leads o he developmen of enrepreneurship. In economic lieraure, here has been voluminous work, which highlighs he causaliy beween rade openness and GDP growh. Jin (2) assered ha he eliminaion of rade barriers assis o sabilise he economic growh rae by improving efficiency and reurn economies. Moreover, rade liberalisaions can improve indigenous echnology which will lead o more efficien producion funcion, and hence produciviy will rise. Levine and Renel (992) described he relaionship beween GDP growh and rade openness by emphasising ha he rade liberalisaions may offer a greaer access o capial goods. Sukar and Ramakrishna (22) saed ha exernal secor openness reduces he hindrances o inernaional rade and such counries can experience compeiively higher GDP growh rae. I is commonly believed ha an open rade regime is imperaive for economic developmen. The experienial evidence regarding he join effec of financial developmen and rade openness variables on GDP growh is underdeveloped. However, several sudies describe he join effec of boh variables on GDP growh i.e., Roubini and Sala-i-Marin (99), Barro (99), Van Den Berg (996) and Yucel (29). The inclusion of boh variable by Roubini and Sala-i-Marin (99) underlined he significance of boh financial developmen as well as rade openness in GDP growh of he counry. In reviewing he preceding sudies, he empirical reliabiliy of he rade liberalisaion, financial developmen and economic growh is varied and imprecise for he case of Pakisan. These ses of incoheren findings could be due o differen sample periods and he diverse ses of economeric mehodologies used such as single equaion (OLS), vecor auogression (VAR) model ec. There are shorcomings o hese echniques. The OLS is no adequae in sudying causaliy or a coinegraion relaionship, while he oher mehodologies bring abou he underlying ime series o have he same order of inegraion. Thus, he Pakisan case sudy of he rade liberalisaion, financial developmen and economic growh needs o be re-examined. This sudy review he shor and long-run relaionship which is based on a furher inclusive sample period han ha used in exising sudies o consen a more convincing conclusion wih he aid of auoregressive disribued lag (ARDL) model, or bounds esing approach, proposed by Pesaran e al. (2) 2. Objecives of Sudy The above discussion confirms he srong linkages beween rade openness, financial developmen and economic growh. The objecive of his paper is o examine he role of rade liberalisaion and financial developmen on economic growh of Pakisan by using ime series daa from This aricle adds hree main conribuions o he exising lieraure on growh, rade and finance. ) I sudies he muual impac of rade openness and financial secor developmen on GDP growh in Pakisan. 2) I uses financial developmen index as an alernaive o Sae Bank of Pakisan s moneary policy o measure he impac on GDP growh. Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 3

3 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 3) I employs recen economeric echniques of ARDL o esimae he relaionship.this ool make he esimaion possible wheher he explanaory variables are I (), or I (). This paper is organised in five secions. Secion 3 provides daa source and mehodological framework. The empirical resuls are presened in Secion 4, while he final secion concludes he sudy. 3. Daa Source and Mehodological Framework The daa were aken from he IFS (Inernaional Financial Saisics), he WDI (World Developmen Indicaors) and he Economic Survey of Pakisan (2-2) for he period All variables are in naural logarihm form and are in billion Pakisan rupees (PKR). The GDP raios of all hese variables were aken for esimaion purposes. An indicaor ha has received scan aenion from economic heoriss is he degree of openness (Harrison 996). For rade openness of an economy, we use (Impor + Expor) as a share of GDP. Financial liberalisaion indicaes Broad Money as percenage of GDP (M/GDP). 3.. Bound Tesing Approach The use of he bounds echnique is based on hree validaions. Firs, Pesaran e al. (2) advocaed he use of he ARDL model for he esimaion of level relaionships because he model suggess ha once he order of he ARDL has been recognised, he relaionship can be esimaed by OLS. Second, he bounds es allows a mixure of I() and I() variables as regressors, ha is, he order of inegraion of appropriae variables may no necessarily be he same. Therefore, he ARDL echnique has he advanage of no requiring a specific idenificaion of he order of he underlying daa. Third, his echnique is suiable for small or finie sample size (Pesaran e al., 2). Following Pesaran e al. (2), we assemble he vecor auoregression (VAR) of order p, denoed VAR (p), for he following growh funcion: Z p = + β i z i μ + ε where z is he vecor of boh x and y, where y is he dependen variable defined as economic growh (GDP), x is he vecor marix which represens a se of explanaory variables i.e., rade openness (TOP), financial developmen (M2) and is a ime or rend variable. According o Pesaran e al. (2), y mus be I() variable, bu he regressor x can be eiher I() or I(). We furher developed a vecor error correcion model (VECM) as follows: Δz p i p = μ + α + λz + γ Δy + γ Δx + ε i i (2) where Δ is he firs-difference operaor. The long-run muliplier marix λ as: λyyλyx λ = λxy λxx The diagonal elemens of he marix are unresriced, so he seleced series can be eiher I() or I(). If λ YY =, hen Y is I(). In conras, if λ YY <, hen Y is I(). The VECM procedures described above are imperaive in he esing of a mos one coinegraing vecor beween dependen variable y and a se of regressors x. To derive model, we followed he posulaions made by Pesaran e al. (2) in Case III, ha is, unresriced inerceps and no rends. Afer imposing he resricions λ YY =, μ and () Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 32

4 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 α =, he GIIE hypohesis funcion can be saed as he following unresriced error correcion model (UECM): Δ( GDP) + r Where GDP TOP M2 = β + β ( GDP) β Δ( M 2) 7 i + β ( TOP) 2 + β ( M 2) 3 β Δ( GDP) β Δ( TOP) +...(3) Δ is he firs-difference operaor and u is a whie-noise disurbance erm. + p = Gross Domesic Produc (Billion PKR); = Trade Openness (X+M/GDP); = Broad Money Supply as percenage of GDP. Equaion (3) also can be viewed as an ARDL of order (p, q, r). Equaion (3) indicaes ha economic growh ends o be influenced and explained by is pas values. The srucural lags are esablished by using minimum Akaike s informaion crieria (AIC). From he esimaion of UECMs, he long-run elasiciies are he coefficien of one lagged explanaory variable (muliplied by a negaive sign) divided by he coefficien of one lagged dependen variable (Bardsen, 989). For example, in equaion (3), he long-run inequaliy, invesmen and growh elasiciies are ( β / β 2 ) and ( β / β 3 ) respecively. The shor-run effecs are capured by he coefficiens of he firs-differenced variables in equaion (3). 4 i + q Afer regression of Equaion (3), he Wald es (F-saisic) was compued o differeniae he long-run relaionship beween he concerned variables. The Wald es can be carry ou by imposing resricions on he esimaed long-run coefficiens of economic growh, inequaliy, invesmen and public expendiure. The null and alernaive hypoheses are as follows: H = β = β 2 = β 3 = (no long-run relaionship) Agains he alernaive hypohesis H β β 2 β 3 (a long-run relaionship exiss) The compued F-saisic value will be evaluaed wih he criical values abulaed in Table CI (iii) of Pesaran e al. (2). According o hese auhors, he lower bound criical values assumed ha he explanaory variables x are inegraed of order zero, or I(), while he upper bound criical values assumed ha x are inegraed of order one, or I(). Therefore, if he compued F-saisic is smaller han he lower bound value, hen he null hypohesis is no rejeced and we conclude ha here is no long-run relaionship beween povery and is deerminans. Conversely, if he compued F-saisic is greaer han he upper bound value, hen agriculure expendiure and is deerminans share a long-run level relaionship. On he oher hand, if he compued F-saisic falls beween he lower and upper bound values, hen he resuls are inconclusive. 4. Resuls and Discussions The sandard Augmened Dickey-Fuller (ADF) uni roo es was exercised o check he order of inegraion of hese variables. The resuls obained are repored in Table. Based on he ADF es saisic, i was iniiae ha ou of hree variables, 2 have uni roo i.e., GDP and TOP, while M2 is I() variable. Noiceably, he mixure of boh I() and I() variables would no be possible under he Johansen procedure. This gives a good jusificaion for using he bounds es approach, or ARDL model, which was proposed by Pesaran e al. (2). 5 i Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 33

5 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 Table : Uni Roo Esimaion Level s Difference Variables Consan Consan Consan Consan and and Trend Trend GDP 5.42 () -.42 () -3.86*() *() TOP () -3.2 () -7.62*() *() M () *(2) -9.7*() *() Noe: The null hypohesis is ha he series is non-saionary, or conains a uni roo. The rejecion of he null hypohesis is based on MacKinnon (996) criical values. The lag lengh are seleced based on SIC crieria, his ranges from lag zero o lag wo. *, ** and *** indicae he rejecion of he null hypohesis of non-saionary a %, 5% and % significan level, respecively. The esimaion of Equaion (3) using he ARDL model is repored in Table 2. Using Hendry s general-o-specific mehod, he goodness of fi of he specificaion, ha is, R- squared and adjused R-squared, is.765 and.6 respecively. The robusness of he model has been definie by several diagnosic ess such as Breusch- Godfrey serial correlaion LM es, ARCH es, Jacque-Bera normaliy es and Ramsey RESET specificaion es. All he ess disclosed ha he model has he aspiraion economeric properies, i has a correc funcional form and he model s residuals are serially uncorrelaed, normally disribued and homoskedasic. Therefore, he oucomes repored are serially uncorrelaed, normally disribued and homoskedasic. Hence, he resuls repored are valid for reliable inerpreaion. Table 2: Esimaed Model Based on Equaion (3) Dependen Variable: Log (GDP) Variable Coefficien Sd. Error -Saisic LOG(GDP(-)) * LOG(TOP(-)).75*** LOG(M2(-)).4656* C.74499* DLOG(GDP) * DLOG(GDP(-)) *** DLOG(TOP) DLOG(TOP(-)) DLOG(M2).5489** DLOG(M2(-)) * MA() * Model crieria / Goodness of Fi: R-square =.765; Adjused R-square =.6; Wald F-saisic = 5.58 [.7]*. Diagnosic Checking: JB = [.334]; LM- =.54 [.37]; LM-2 =.45 [.53]; LM-3 =.49 [.69]; ARCH () =.28 [.542]; ARCH-2 =.44 [.24]; ARCH-3 =.699 [.562]; Whie Heeroskedasiciy =.34 [.97]; Ramsey RESET =.9 [.55] *, ** and *** indicae significance a.,.5 and. level respecively. Probabiliy values are quoed in square brackes. MA and ARCH denoe LM-ype Breusch-Godfrey Serial Correlaion LM and ARCH es, respecively, o es for he presence of serial correlaion and ARCH effec. JB and Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 34

6 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 RESET sand for Jarque-Bera Normaliy Tes and Ramsey Regression Specificaion Error Tes, respecively. In Table 3 he resuls of he bounds co-inegraion es demonsrae ha he null hypohesis of agains is alernaive is easily rejeced a he % significance level. The compued F-saisic of 5.58 is greaer han he lower criical bound value of 3.74, hus indicaing he exisence of a seady-sae long-run relaionship among GDP, TOP and M2. Table 3: Bounds Tes for Coinegraion Analysis Criical value Lower Bound Value Upper Bound Value % % % Noe: Compued F-saisic: 5.58 (Significan a.5 marginal values).criical Values are cied from Pesaran e al. (2), Table CI (iii), Case : Unresriced inercep and no rend. The esimaed coefficiens of he long-run relaionship beween GDP, TOP and M2 are expeced o be significan, ha is: D log( GDP) =.74 * +.453*** log( TOP) * log( M 2)...(4) Equaion (4) and Table 4 indicaes ha boh rade openness and financial liberalisaion have a posiive impac on economic growh. If here is one percen increase in rade liberalisaion, economic growh increases by.453 percen and.657 percen respecively. This analysis demonsraes ha, in he long-run, rade and financial led growh hypohesis does hold in Pakisan, as boh variables are posiive and significan effec on economic growh over a period. Table 4: Long-Run Elasiciies and Shor-Run Elasiciies of Economic Growh in Pakisan: Based on Equaion (3). Long-Run Esimaed Coefficien Variable Coefficien TOP.453*** M2.657*. Shor-run Causaliy Tes (Wald Tes F-saisic): ΔTOP ΔM *** 8.268* (.75) (.) *, *** denoe significan a % and % level. Figures in brackes refer o marginal significance values. The dynamic shor-run causaliy among he relevan variables is shown in Table 4, Panel II. The causaliy effec can be acquired by resricing he coefficien of he variables wih is lags equal o zero (using Wald es). If he null hypohesis of no causaliy is rejeced, hen we wrap up ha a relevan variable Granger-caused economic growh. From his es, we iniiae ha boh variables i.e., rade openness and M2/GDP are saisically significan o Granger-caused economic growh a and percen significance level. To sum up he findings of he shor-run causaliy es, we conclude ha causaliy running from rade openness o economic growh and M2 o economic growh respecively. 5. Summary and Conclusion This paper has esimaed he impac of rade openness and financial developmen on economic growh of Pakisan by using ime series daa from by employing Bound Tesing approach. The analysis demonsraes ha in he long-run, rade openness Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 35

7 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 and financial developmen boh increases economic growh by almos.453% and.657% respecively. While in he shor-run, he resuls indicae direcional causaliy beween rade openness (TOP) o Granger-caused economic growh (GDP) and M2 Granger-caused GDP. I is manifes ha economic growh is sensiive o changes boh rade and financial liberalisaion policies. Therefore, he governmen should realise effecive macro-economic policies along wih momenous improvemens in he srucure and funcioning sysems of governance for sabilising economic growh along wih rade and financial liberalisaion reforms. 6. References Ansari, M.I. (22) Impac of financial developmen, money, and public sending on Malaysian Naional Income: an economeric sudy. Journal of Asian Economics 3, Aziz, J and Chrisoph, D. (22) Growh-Finance Inermediaion Nexus in China, IMF Working Paper No. WP/2/94, Inernaional Moneary Fun: Washingon D.C. Bardsen, G. (989) Esimaion of long-run coefficiens in error correcion models, Oxford Bullein of Economics and Saisics, 5, Barro, R.J. (99) Economic Growh in a Cross Secion of Counries, Quarerly Journal of Economics, Vol. 6, pp Bencivenga, V.R, and B.D. Smih (99) Financial Inermediaion and Endogenous Growh, Review of Economic Sudies, Vol.58, No.2, pp Bhagwai, J Expor-Promoing Trade Sraegy: Issues and Evidence, The World Bank Research Observer, pp Darra, Ali. F. (999) Are Financial Deepening and Economic Growh Causaliy Relaed? Anoher Look a he Evidence, Inernaional Economic Journal, Vol.3, No.3, pp De Gregorio,J., and P.E. Guidoi, (995) Financial Developmen and Economic Growh, World Developmen, Vol.23, No.3, pp Economic Survey of Pakisan (2-2). Governmen of Pakisan, Finance Division, Economic Advisor s Wing Pakisan. Fry, M.J. (995) Money, Ineres Rae, and Banking in Economic Developmen, Second Ediion, London: The Johns Hopkins Universiy Press. Fry, M.J. (997) In Favor of Financial Liberalizaion, Economic Journal, Vol.7, pp Greenwood, J. and Smih, B. (997) Financial Markes in Developmen and he Developmen of Financial Markes, Journal of Economic Dynamic and Conrol, Vol.2, pp IFS (28) Inernaional Financial Saisics 28, Inernaional Moneary Fund, Washingon. hp:// Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 36

8 Journal of Inernaional Academic Research (2) Vol., No.2. 3 Augus 2 Jin, J. C. (2) Openness and Growh: An Inerpreaion of Empirical Evidence from Eas Asian Counries, The Journal of Inernaional Trade and Economic Developmen, Vol.9, No., pp.5-7 King, R.G. and Levine, R. (993) Finance and Growh: Schumpeer Migh be Righ, Quarerly Journal of Economics, Vol. 8, pp Krueger, A.O. (998) Why Trade Liberalizaion is good for growh, Economic Journal, pp Lee, Jong-Wha (993) Inernaional Trade Disorions, and Long-run Economic Growh, IMF Saff Papers, pp Levine, R. (997) Financial Developmen and Economic Growh: Views and Agenda, Journal of Economic Lieraure, Vol. 35, pp Levine, R. (24) Finance and Growh: Theory and Evidence, NBER Working Paper No. 766 Levine, R and Renel, D. (992) A Sensiiviy Analysis of Cross-Counry Growh Regressions, American Economic Review, Vol. 82, pp Lucas, R.E. Jr. (988) On he Mechanics of Economic Developmen, Journal of Moneary Economics, Vol.22, pp.3-42 Mckinnon, R.I. (973) Money and Capial in Economic Developmen, Brooking Insiuion, Washingon, DC Pesaran, M.H., Y. Shin., and Smih R. (2) Bounds esing approaches o he analysis of level relaionships, Journal of Applied Economerics, 6, Rivera-Baiz, L.A. and P.M. Romer (99) Inernaional Trade wih Endogenous Technological Change, European Economic Review, pp Roubini, N and Sala-i-Marin, X. (99) Financial Developmen, Trade Regimes and Economic Growh, NBER Working Paper No Shaw, E.S., (973) Financial Deepening in Economic Developmen, Harvard Universiy Press, Cambridge, M.A. Sukar, Abdulhamid, and G.Ramakrishna (22) The Effec of Trade Liberalizaion on Economic Growh: The case of Ehiopia, Finance India, Vol. XVI, No.4, pp World Bank (989) World Developmen Repor 989, Oxford Universiy Press, New York. Van Den Berg, H., (996) Does simulaneiy exaggerae empirical ess of rade-growh relaionship, Applied Economic leer, 3: World Bank. (29) World Developmen Indicaors (WDI). Washingon, DC. hp:// Yucel, F. (29) Causal Relaionships beween Financial Developmen, Trade Openness and Economic Growh: The Case of Turkey, Journal of Social Sciences 5(): 33-42, 29 Trade Liberalisaion, Financial Developmen and Economic Growh: Evidence from Pakisan 37