Export-the departminant of economic growth in Asean developing countries 1986-2001, the case of VN

By using both descriptive and econometric method, the study examines the determinants of growth with an emphasis on the role of exports on economic growth in the ASEAN-5 developing count

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAM- THE NETHERLANDS PROJECT ON DEVELOPMENT

ECONOMICS

EXPORTS - THE DETERMINANT OF ECONOMIC

GROWTH IN ASEAN DEVELOPING COUNTRIES 1986-2001,

THE CASE OF VIETNAM

A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE DECREE OF

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

BY HAVANDUNG

11

ACKNOWLEDGEMENTS

First of all, I would like to express my sincere and grateful appreciation to my academic supervisor MA Nguyen Huu Loc for his guiding me during every step in my study, especially during my time of writing thesis

I would also like to express my grateful thanks to all professors, lecturers in Vietnam - the Netherlands Project, especially Dr Youdi Schipper, Dr Gabrielle Berman, and Dr Karel Jansen for their precious lectures and assistance during the period of writing thesis proposal Furthermore, I would like to thank all the staffs of the project, especially the librarian Ms Dang Kim Chi, and the project secretary Ms Dinh Anh Nguyet

I would like to express my sincere thanks to all of my classmates in class 8, who have helped me a lots with their encouragements, collaboration, and ideas during my study as well as during the time I do my thesis

Above all, I am indebted to my grandmother, my parents and my daughters, who have given me a lot of encouragement, sympathy, and support during my study

11l

By using both descriptive and econometric method, the study examines the determinants

of growth with an emphasis on the role of exports on economic growth in the ASEAN-5 developing countries during the period of 1986-2001 The econometric method is based on the neoclassical model, using panel data of five countries during sixteen years The empirical findings reveal that capital; labor force, export growth, spending on education, and external debts are determinants of growth In which, external debt and spending on education have negative effect on growth while the rest has positive impact on economic growth In relation with the role of exports, the study has found that exports have positive effect on economic growth in these countries, and this result is consistent with those in previous studies It also suggests that the opened-door policy in these countries has been effective and it should be considered carefully in order to contribute more to economic growth

IV

TABLE OF CONTENTS

C ertifi cation

Acknowledgements

Abstract

Tables of contents

Lists oftables

Lists of figures

Acronyms

CHAPTER 1: INTRODUCTION

I.l Problem statement 1

!.2 Overall objectives 3

!.3 Scope and limitation of the study 3

!.4 Methodology and data 4

!.5 Structure of the thesis 4

CHAPTER II: LITERATURE REVIEW ILl Definitions 6

1!.2 Literature review 7

11.2.1 Growth theories 7

1!.2.1.1 Keys ian Growth 7

11.2.1.2 The neoclassical growth model 10

11.2.1.3 The endogenous growth theory 13

11.2.2 The traditional theory of international trade and development 17

11.2.3 Effects of Exports on Growth 19

v

II.3 Empirical Studies 28

II.3.1 Study of H Sun and A Parikh (1996) 28

II.3.2 StudyofY A Al-Yousif(1999) 29

II.3.3 Study ofT Lloyd, 0 Morrissey, and R Osei (2001) 31

II.3.4 Study of G K Nigugala (1999) 32

II.3.5 Study ofT Gylfason (1998) 33

11.3.6 Study of E J Sheeney (1992) 34

II.3.7 StudyofM A B Sidique and E A Selvanathan (1998) 35

11.4 Conclusions 37

CHAPTER III: AN OVERVIEW OF ECONOMIC PERFORMANCE AND EXPORTS IN ASEAN-5 DEVELOPING COUNTRIES III I A background of five ASEAN developing countries 39

III.2 Export performance and sources of export growth of ASEAN-5 in recent years 40

III.2.1 Economic growth in ASEAN-5 40

III.2.2 Export Performance of ASEAN-5 in the studying period 42

III.2.3 Sources of Export Growth 44

III.3 Vietnamese exports in the studying period 47

III.3.1 Vietnam trade performance after applying 'renovation' policy 47

III.3.2 The commodity composition of exports 50

III.3.3 Main trading partners ofVietnam 52

III.4 Conclusions 55

CHAPTER IV: DETERMINANTS OF ECONOMIC GROWTH IN ASEAN-5 DEVELOPING COUNTRIES IV.1 Methodology 56

Vl

IV.2 Descriptive Statistics 60

IV.3 Econometric Model 62

N .3 1 Model Specification 62

N.3.2 Estimation results 66

IV.4 Conclusions 71

CHAPTER V: CONCLUSIONS AND POLICY RECOMMENDATIONS V 1 Conclusions 72

V.2 Policy recommendations 75

V.3 Suggestions for further study 77 Bibliography

· LIST OF TABLES

Table 2.1: Determinants of economic growth

Table 3.1: Growth rate of export in ASEAN-5, 1986-2001

Table 3.3: Vietnam: Commodity composition of exports, 1990-2001

Table 4.1 Description of variables

Table 4.2: Test for rank correlation between export growth and GDP growth

LIST OF FIGURES

Figure 2.1: Employment and foreign exchange effects of export expansion

Graph 3.1: GDP growth rate of ASEAN-5

Chart 3.1 Market's share ofVietnamese exports, 1995

Chart 3.3 Market's share ofVietnamese exports, 2001

Vlll

ASEAN Free Trade Area

Association of South East Asian Nations

Augmented Dickey Fuller

Council for Mutual Economic Assistance

Foreign Direct Investment

Gross Domestic Products

General Statistics Office

Seemingly Unrelated Regression

CHAPTER I: INTRODUCTION 1.1 PROBLEM STATEMENT

Vietnam had made its unification more than ten years before it started the economic reform to take the economy out of the crisis in 1986 (Hoang, 1996) Vietnam's economic reform or 'doi moi' (innovation) has been done for more than sixteen years and it gets many successes Gross Domestic Products (GDP) increases more than twice in the past ten years, economic structure changes in the right direction of reducing the ratio of agriculture over GDP and increasing the ratio of industry and service over GDP (Nguyen, 2002) From the beginning of innovation, Vietnam has gained a considerable growth with the average of GDP of 7.55 per cent per year (Vo, 2002) In which, the year 1995 is considered as the most successful for growth performance with the growth rate of GDP reaching 9.5 per cent Then, there is a bit slowdown in GDP growth rate It is only 5.8 and 4.8 per cent in 1998 and 1999, respectively However, it increases in 2000 and 2001 with the growth rate of 6.7 and 6.8 per cent (General Statistic Office (GSO), 2002) As a result of the economic growth, the living standard is improved dramatically (Nguyen, 2002)

In accordance with GDP growth, the 2002 World Bank report shows that between 1986 and

2001, exports have increased by an average of around twenty three per cent leading to an expansion in sectors that employ large number of people, combined with a stable macroeconomic environment and reforms for favorable investment climate, it generated exceptional growth in GDP (World Bank, 2002) Not only the total volume of exports increases, the structure of exports has changed as well Vo (2002) shows that while primary exports have decreased the share in total exports from year to year, manufactured exports have increased from only ten per cent in 1991 to forty per cent in 1999 (Vo, 2002) The Vietnamese economic performance as well as the export performance is so good in the

difficult circumstance of collapse of trade relations with Council for Mutual Economic Assistance (CMEA) and the fall of aid from Soviet Bloc

When economists consider the effect of export growth on economic growth, there are two groups of thought First, Krueger argues that economic growth could be gained when the country experienced growth of export earnings (Krueger, 2000) Other writers such as Feder (1983), Nidugala (1994), Sun and Parikh (1996), Al-Yousif (1999), and Lloyd, Morrissey, and Osei (200 1) also find that there is a positive effect of export growth on economic growth Additionally, Nidugala finds an interesting point that manufactured exports have significant influence on GDP growth for the case of India This shows that economic structure also has a role in the development process of India In contrast, Raul Prebish and Hans Singer argued that not only primary exports face sluggish growth of demand, but over time prices of these commodities will fall in the world market, so they do not agree with an positive effect of exports on economic growth in long run (Gillis and al, 1996) Another author finding the same conclusion is Sheerey with the study of cross-section of 53 countries in the world After examining the role of exports on economic growth, he concludes that exports have not got the clear role in economic growth (Sheerey, 1992) Siddique and Selvanathan agree with this idea when they do their research for Malaysia and find that their results do not give any evidence

to support the export-led economic growth hypothesis They also indicate that for the case of Malaysia manufactured exports as the same as total exports have no role in economic growth (Siddique and Selvanathan, 1998) In Vietnam, there is a debate on the role of exports on economic growth While many authors such as Nguyen (1997), Nguyen (2002), and Vo (2002) have suggested a policy with more concentration on exports, Nguyen (2000) shows that imports of machinery have increased from 21.8 percent in 1991 to 28 percent in 1999, and this has contributed in pushing domestic production and thus, growth So, it is necessary

to push this kind of imports (Nguyen, 2000)

So, this paper aims at investigating the role of exports on economic growth, and through which to find out what are determinants of economic growth in Vietnam from the year of innovation 1986 to 2001, also reference with other ASEAN developing countries

1.2 OVERALL OBJECTIVES

The study concentrates on economic dimensions of economic growth and exports, as well as other determinants of growth in Vietnam It is envisaged that this will correlate the export growth rate, investment, human capital, which are necessary conditions for sustainable economic growth

The overall objectives of this study will therefore be to identify and qualify, through economic investigation of growth, the relationship between export growth and economic growth, and last suggest trade policies stimulating further economic growth

The study has two specific objectives, with an emphasis on the later one:

1 What are determinants of GDP growth in ASEAN-5 developing countries including Thailand, Malaysia, Indonesia, the Philippines, and Vietnam

2 Is there a positive effect of the growth rate of exports on the growth rate of GDP

in ASEAN developing countries during the period of 1986-2001?

1.3 SCOPE AND LIMITATION OF THE STUDY

The year 1986 is considered as the initial year of totally innovative in Vietnam since the innovation in the mid-1986 From 1986, data available is not sufficient enough to econometric model and thus lead to unreliable results So, to increase the sample size the study chooses additional four ASEAN economies including Thailand, Malaysia, Indonesia, and the Philippines These countries are chosen because of two reasons The first reason is that all these countries are located in Southeast Asia and are members of AFTA The second reason is that the economic background of these countries is quite similar each other These countries are pursuing regional and international integration with greater openness of the

economies as well as trade liberalization They all first develop by industrialization of substitution strategy and then shifted into export-oriented strategy (Bende-Nabende, 1999) For limitation, since some data are missed and not available, the thesis just focuses on some main determinants of growth The study also just focuses on visible exports while it ignore invisible exports due to the reason of data constraint Another limitation is some data are not available, so it will reduce the observations of regression model

import-1.4 METHODOLOGY AND DATA

Both qualitative and quantitative methods are used to analyze, however econometric method

is used as the main methodology

The econometric method will be used to analyze the impacts of exports on economic growth

in ASEAN developing countries and Vietnam It will investigate how export growth can affect on economic growth in these countries

Most of data come from CD-Rom named World Development Indicator of the World Bank group Another source of data is from Statistical Year Books (GSO, various years) as well as

in the book named World Development Indicator 2001 and 2002 The World Investment Report 1999 of United Nations Conference on Trade and Development, United Nations, and The World Tables 1995 ofthe World Bank are also used to extract data

These sources are official so, data used are reliable and acceptable for the study

1.5 STRUCTURE OF THE THESIS

Basing on the objective and methodology, the thesis is classified into five chapters

Following introduction, chapter two introduces the literature review It focuses on the growth theories, trade theories, and effects of exports on economic growth Then, it also includes some empirical studies, which examine the relationship between export growth and economic growth

Chapter three introduces an overview of economic performance and exports in ASEAN-5 developing countries from 1986 Especially, the case of Vietnam will be examined more carefully in order to have a general picture of Vietnamese economy since applying the 'innovation' policy in mid-1986

Chapter four is the main one with the qualitative and quantitative methods in examining the relation between economic growth and export growth It consists of methodology, descriptive statistics and the derived model Then, the estimation results are presented After that hypotheses testing are done within the model in order to give reliable findings from the regression results and answer the research question

Finally, chapter five will close the thesis with some conclusions and policy implications, basing on the findings in the previous chapter It also offers some suggestions for further studies

CHAPTER II: LITERATURE REVIEW

In order to understand the relation between economic growth and its determinants including exports, it is necessary to examine the theoretical framework This chapter first introduces the definitions of key concepts and then the literature review will be presented In the literature review, there are three sub-parts: the first sub-part is composed of growth theories including the Keysian growth, the neoclassical model, and the endogenous growth theory From these, some determinants of growth are drawn Then in the second sub-part, theories relating international trade and economic growth are presented, and last, effects of exports on growth will be examined The third part introduces some previous empirical studies, which examine the determinants of economic growth, including export growth Finally, conclusion for theories and empirical study will be drawn

Last, Pearce (1996) states that economic growth is 'typically taken to the mean an increase in real level of net domestic products although the measure will then be sensitive to the way in which domestic product is measured Thus an economy with a large sector containing battered goods and un-recovered consumption of its own product (e.g farmers' consumption

of their own product) may raise its actual level of domestic product without the recorded level showing an increase' (Pearce, 1996: p120)

11.2 LITERATURE REVIEW

11.2.1 Growth theories

In the last haft of century, there are three waves of growth theory: firstly, the work of Harrod and Domar (or Keynesian Growth), then neoclassical model of Solow, and last, endogenous growth theory by Romer and Lucas (Ruttan, 2001 )

11.2.1.1 Keysian Growth

The model of Roy Harrod (1939) and Evsey Domar (1946) is built basing upon Keynesian economics

The simple model of economic growth is expressed as following (Todaro, 1994): we denote k

as the capital-output ratio, and s is the proportion of saving (S) over national income (Y)

S =sY

Investment (I) is defined as the change in capital stock (K)

Capital stock is a part of output so

The Two-Gap Model

The two-gap model is quite similar to the Harrod-Domar model but it puts a further assumption that investment program needs an import component in the form of machinery or intermediate goods So, the economic growth can be limited by two constraints: the total amount of available capital for investment and the amount of foreign exchange for imports (Kasliwal, 1995)

dY=K.I

From the national income identity

Y=C+I+(X-M)

S=Y-C

M- X= F where F is capital inflows

Insert (3) into (2) and combine with (4), it results

(5)

(6) The equation (6) shows that domestic and foreign savings determine the growth rate However, the foreign exchange constraint may be the one problem To examine this, total imports are split up in imports of capital goods (Mk, proportional to the level of investment) and other imports (Mi, proportional to the level of output)

dY=K.MIJmK

Assuming furthermore that X = e Y

From (7) and ( 4)

=> MK =F +X- Mi orMK =F+ e.Y -mi.Y

Dividing both sides of (12) by Y, it gives the result of growth rate:

mK

(10) (11)

(12)

(13)

The equation (13) sets the growth rate as determined by net export earnings, net receipts of factor services and other current transfer, and foreign savings The equations (6) and (13) suggest a positive impact of capital and export on growth in the two-gap model The equation (5) shows the role of foreign capital Foreign capital will help one country to fulfill the gap between investment and saving of the country

The two-gap model is a useful starting point for the analysis It is a single and powerful tool

to draw attention to some crucial variables determining the relationship among capital, export, and economic growth It can be used as a quick device to calculate growth while other elements are held constant It also shows the important role of foreign capital in fostering growth However, it bases on assumptions of constant parameters, which is unrealistic in the real life

In conclusion, the Harrod-Domar model gives an idea for source of economic growth, which

is the saving rate of the economy However, the model does not always work since the model has used inappropriate or irrelevant assumptions about the necessary structural, institutional, and attitudinal conditions The model considers all economies with well-integrated commodity and money market, highly developed transport facilities, well-trained and educated labor force, efficient government bureaucracy, etc (Todaro, 1994) Actually, these

assumptions are unrealistic even with developed economies The differences in working conditions, education, national resources have made different growth between among economies It also neglect to the role of price index in the model

So, this theory is considered as one of the most fundamental "tricks" of economic growth but

it is not widely applied for real economies

11.2.1.2 The Neoclassical Growth Model

Solow (1956) and Swan (1956) have developed the neoclassical growth model It is an aggregate, constant-returns-to-scale production function that combines labor and capital (Agenor and Montiel, 1996) Technology improves are assumed as an exogenous rate while savings are assumed to be a fixed fraction of output

The production function is Cobb-Douglas; output per capita y is given by:

y=Ak 1

Where k denotes as the capital/labor ratio and A as the level of technology

The capital accumulation is given by

k=sy-5k s > 0, <1 (2) Where s denotes the propensity to save the rate of depreciation of physical capital The neoclassical growth model leads to the 'source-of-growth' approach, which uses an aggregate production function to decompose growth into 'contributors' from different sources These sources can be named as the growth rate of factor inputs weighted by their shares plus a residual This residual is often called 'technical progress' or the growth rate of total factor productivity (TFP) (Agenor and Montiel, 1996: p513-14)

(3) Where Ui is the elasticity of output with respect to input i, and gA is the growth rate of total factor productivity and as a residual

Technological Progress

The assumption of constant technology is unrealistic so in 1950s and 1960s, the neoclassical economists amended the basic model and let technology improve over time The technological improvement is exogenous To introduce exogenous technological progress into the model, most economists use neutral inventions, which do not save relatively less capital input or relatively less labor input (Barro, 1995)

When A and L are integrated, AL means effective labor and is called labor augmenting or Harrod-neutral The model is then expressed in the new form

Y = F(K, AL)

AL- AL'

Where F I AL = y*: output per unit of effective labor

Kl AL = k*: amount of capital per unit of effective labor

y* = f(k*) (Romer, 1996: p8)

(4)

Or in short time, the increase of output is determined by the increase of amount of capital per unit of effective labor The Harrod-neutral has emphasized the role of capital as the only one determinant in fostering growth in short-run

In the model, Solow has explained the cross-country differences in the growth rate by mainly

on transition dynamics and he shows the technical progress as the source of sustained growth However, the diminishing returns have prevented the model from providing an explanation for the wide variation across countries in either per capita income or growth rate In addition, since population growth and technological change are assumed exogenous, the model does not give explanation for the mechanisms generating steady-state growth, and therefore there

is no evaluation of the mechanisms through which government policies can influence the growth process (Agenor and Montiel, 1996) Moreover, the model assumes unrealistic

efficient market and doesn't give any explanation for the sources of technical progress, which can be considered as indirect contribution to growth

The Augmented Solow Model

Mankiw, Romer, and Weil (MRW) (1992) extend the Solow model by adding human capital accumulation They introduce the stock of human capital (H) into the production function

(5)

As before, the production function has constant returns to scale and diminishing returns to all capital We divide both sides by effective labor (AL)

(6)

where: h* = H/(AL) and h = H/L

The equation shows that output per worker (y) depends on skills per worker (h) and capital per worker (k) as well as technology (A)

Assuming that a constant fraction of income is invested in physical capital (s) and a constant fraction of income is invested in human capital ( sH), the growth rate of human capital is n and

both types of capital depreciate at the same rate (l5) The accumulation equations for physical

and human capital are then:

k • = sy • I k • - ( n + g + 5 ) (7)

(8)

Setting k = 0 and h = 0 we obtain the steady state values ofk* and h*:

(9) (10) Substituting (9) and (1 0) into (6), we have the steady state value of output per worker:

(11)

The equation (11) shows that besides A, s, and (n + g + o); the rate of human capital (sH) also affects on the steady state value of output per worker

To estimate the rate of growth, we substitute into Y/L = AkuhP, then taking logs of both sides, and we get an estimating equation with human capital

log(y) = log(A(O)) + og(s) + og(sH)- log(n + g + o) (12)

This model also faces the problem that the original Solow model does That is no explanation for the sources of technological progress It does not seem to provide a satisfactory solution

to the shortcomings of technology gaps The lack of supporting empirical relevance is also a shortcoming of the growth theory

However, in the model, three determinants of growth are clearly defined They are human capital, physical capital and technological progress Among these, capital plays a crucial role

to growth as show in equation 12

In conclusion, the neoclassical growth model has well developed from the basic model The following models have gradually removed the shortcomings of previous ones From just one determinant of growth - physical capital, the followings have developed and allow human capital to grow and technological progress to improve over time This has made the model become more realistic and it can be able to apply for real economies

11.2.1.3 The Endogenous Growth Theory

A new boom of research on economic growth is beginning by the work of Romer (1986) and Lucas (1988) and this is called endogenous growth theory

The endogenous growth theory has proposed a variety of channels through which steady-state growth is reached endogenously First, it is necessary to examine the role of externalities and increasing returns to scale, then the human capital accumulation

Externalities and increasing returns

There are two broad approaches following the way that relaxes the assumption of diminishing returns to capital (Agenor and Montiel, 1996) First, some economists consider all production inputs as some forms of reproducible capital including physical capital and human capital (Lucas, 1988) or 'state of knowledge' (Romer, 1986) Robelo (1991) has developed the AK model along this line

From the equation

Setting 8 = 0

=>y=Ak

Where k is measure of the physical and human capital

The growth function exhibits the constant returns to scale, but not diminishing returns to capital The steady-state growth per capita is then

g=sA-8 The implication of the equation is that an increase in the saving rate will raise the growth rate per capita In addition, the AK model implies that poor nations with the same characteristic of technological degree as other nations always growth at the same rate as rich countries, regardless ofthe initial level of income (Agenor and Montiel, 1996)

The second approach of examine endogenous growth has introduced externalities in the growth process In the model, externalities exist in the form of technological knowledge for all firms and they are used for developing new methods of production However, there are some exceptions such as Lucas (1988) has considered externalities as the form of public learning, and Barro (1990) has introduced externalities as public investment

Human capital and knowledge

The accumulation of human capital is one particular source of externalities that has been emphasized in recent growth theory In his model, Lucas (1988) has developed upon the idea

that individual workers are more productive, regardless of their skill level, if other workers have more human capital Lucas has developed the model as following

capital converge to a constant In addition, the model implies that under purely competitive equilibrium, external effects lead to an under-investment in human capital because private agents do not consider the external benefits of human capital accumulation The equilibrium growth rate is smaller than the optimal growth rate because of the externalities Since the growth rate is determined by the rate of investment in human capital, the externality implies that with more investment in human capital, the growth would be higher So, government policies are necessary to increase the equilibrium growth rate up to the optimal growth rate and subsidy on human capital formation would make a substantial increase in the economic growth rate (Agenor and Montiel, 1996)

Romer (1986) has proposed another approach to accessing the role of external effect in his framework He considers the source of externality is the stock of knowledge rather than the stock of human capital Knowledge is produced by individuals, but since newly produced knowledge can be partially and temporarily kept secret, the production of goods and services depends on not only private knowledge but also the aggregate stock of knowledge Next,

Romer (1990) has explained endogenously the decision to invest in technological change with a model based on a distinction between a research sector and the rest of the economy In this work, he states that firms cannot benefit all from knowledge production, implying that the social rate of return exceeds the private rate of return to certain forms of capital accumulation This leads to a conclusion that tax and subsidy can promote the rate of economic growth (Romer, 1990)

The shortcoming of the model is that the endogenous growth theory has faced a classic policy problem associating with the production of knowledge under the conditions of increasing returns and imperfect competition

In Romer model, new ideas, which depend on the number of researchers engaging the discovery process, can create technological change, and in tum, technological change requires government provision of intellectual property rights (Riedle, 2003) The endogenous model has solved the problem of source of technological change While in Solow model, technological change is not explained, the Romer model explains it as a result of investment

in human capital or new ideas from researching In addition, other advances of these theories

is that in the models, the authors have considered the roles of the government, the effects of per capita income and wage rate of population

The endogenous growth model has developed into higher level compared to previous ones With the close attention to empirical studies and to the relation between theory and data, the endogenous growth model has been more widely applied for real economies

In conclusion, the growth theories from Keysian growth to neoclassical growth and endogenous growth have explained the sources of growth From one determinant of growth -physical capital, the followings have found other two main determinants of growth such as human capital, technological progress Besides, some others are institutional conditions,

initial income, and wage rate of population The following theories become more and more suitable for applying in real economies

Since the study places an emphasis on the role of exports on growth, it is necessary to review the trade theories that relate exports and economic growth

11.2.2 The Traditional Theory of International Trade and Development

Ricardo invented one of the most important theories of international trade in 1817 and it's

called the law of comparative advantage in the book entitled Principles of political economy and taxation (Salvatore, 1995)

According to the law of comparative advantage, both nations can gain from trade even though one nation is less efficient than the other nation in producing both commodities This Law suggests that the first nation should specialize in the production of the commodities in which its absolute advantage is smaller and export this kind of good, which is said to have comparative advantage At the same time, the nation imports the commodity in which its absolute advantage is bigger, and this good is called to have comparative disadvantage The concept of relative cost and price differences is basic to the international trade (Todaro, 1994)

However, the shortcoming of this theory is that it just bases on unrealistic assumptions of the only one factor - labor- of production and labor is homogenous Therefore, the theory cannot

be applied for the real world It is just as a fundamental theory for following trade

The opportunity cost theory

According to this theory, the cost of one commodity is the amount of a second commodity that must be given up to let just enough resources to produce one additional unit of the first commodity So, a nation with lower opportunity cost in the production of one commodity has

a comparative advantage in that commodity There are two cases of the opportunity cost: with constant costs and increasing costs

Under constant costs, the production possibility frontier is a straight line Constant opportunity costs need two conditions First, resources for production are either perfect substitutes for each other or used in fixed proportion in the production of both commodities Second, all units of the same factor are homogenous (Salvatore, 1995)

Increasing opportunity costs mean that a nation must give up more and more of one commodity to have enough resources to produce each additional unit of other commodity Under the increasing opportunity costs, the production possibility frontier is concave from the ongm

Trade between two nations is based on the difference in their relative commodity prices, which reflect their comparative advantage Each nation will specialize in producing the commodity of its comparative advantage and exchange a part of the output for commodity of comparative disadvantage Trade in the both cases of constant and increasing opportunity costs will result in mutual benefit of both nations since they can consume at a point outside the production possibility frontier This means that as trade happen, they can consume more than those they can produce (Salvatore, 1995)

This theory is considered as an advanced step of comparative advantage theory by relaxing the assumption of labor theory of value It shows the reason why nations should engage in trade based on the opportunity costs theory

However, simple assumptions neglecting the role of market, the role of government as well as other factors affecting trade have made the theory become unrealistic and it just has meaning

in giving another explanation for international trade

Relative factor endowments and international specialization: the neoclassical model

This model is developed from the work of Ricardo with the expansion in factor supplies (mainly land, labor and capital) It is modified and refined in the twentieth century by two economists Eli Heckscher and Berti! Ohlin, so it's also called the Heckscher-Ohlin theorem

The Heckscher-Ohlin theorem can be stated as following: A nation will export the commodity whose production requires the intensive use of the nation's relative abundant and cheap factor and import the commodity whose production requires the intensive use of nation's relative scarce and expensive factor In this, the H-0 theorem isolates the differences

in relative abundance among nations as the basic determinant of comparative advantage and international trade So, the H-0 model is often called the factor-proportions or factor-endowment theory

In conclusion, the traditional trade theory is just a static one and it bases on unrealistic assumptions but it is said that it is the most fundamental and famous theory of international trade, which contributes much for the development the world economy Like previous ones, this theory is just in research field and it cannot be used full explanation for international trade nowadays

11.2.3 Effects of Exports on Growth

In the two previous part of literature, the study has presented the growth theories and the determinants of growth in these theories It also shows international trade theories to illustrate how countries benefit when they engage into the international trade in general This part will

in turn present the effects of exports on economic growth It is necessary to state that exports can affect economic growth either to output directly or via determinants of growth indirectly

It is difficult to find out a set of studies that fully examine all aspects of the relationship between exports and economic growth Each study may examine some aspects of the relationship and this study is to combine these studies for coherence First it investigates the effect of exports on demand of the economy leading to a bigger demand for domestic production Second, exports can stimulate savings, and thus investment And third, exports enhance technological progress, human capital and increases productivity

Effect of exports on demand

The effects of exports on demand include the direct effect of export on GDP since exports are parts of GDP; the multiplier effects as well as the effects of backward and forward linkages; and the release of the foreign exchange constraint

First, it is easy to identify that exports have direct effect on economic growth since it is one

of components of GDP Blanchard (2000) has expressed the domestic demand for goods and services as following:

Z=C+I+G-M+X

Where Z represents for total output or GDP, C is consumption, I is investment, G is government spending, M is imports, and X is exports of goods and services from abroad The equation suggests that exports have not only direct effect but also positive impact on output growth He also adds that an increase in exports will lead to an increase in domestic output (Blanchard, 2000)

In addition, exports expansion means larger market capacity, introduction of new products, increase in competitiveness (Hansson, 1993) Incomes and employment from export creation may give direction for expanding domestic production Thirlwall (1994), and Sundrum (in Meier 1994) also argue that export growth can benefit from the expansion of productive capacity, which leads to attain higher level of production possibility frontier, and thus higher level ofwelfare

These above arguments have suggested that exports have contributed directly to economic growth, as it is one of components of growth

Second, the multiplier effects as well as the effects of backward and forward linkages will enhance the effect of exports on demand The multiplier effect appears when an increase in production of any industry will create a multiple increase in production of that industry Linneman et al (1987) also add that multiplier effect appears in both employment and

production since a direct increase in production and employment will generate a multiple increase in production and employment in the economy 'Additional exports will result in a higher level of output in exporting industries and more people will be employed in these industries' (Linneman et al, 1987: p185) Moreover, increased activity of additional exports may foster growth in other sectors of the economy These spread effects are commonly called linkages effects Both in export and linked industries, profit and wage incomes are realized, and in tum these incomes, which are used as either savings or investment, will generate a further increase in production and employment Accompanied with investment, employment generating happens when linkages appear 'The creation of linkages creates a multiplier effect in its own right by enhancing industrial growth technological transfer, and job creation' and 'in Singapore a study of three TNCs has revealed an employment multiplier factor of 1.2

in 1976 to 1.6 in 1980, i.e for every one employee of the TNC there were 0.2 and 0.6 employees created via linkages in 1976 and 1980 respectively' (Bende-Nabende, 1999: p99) Moreover, export sector links closely to primary sector, export sector has used output of primary sector as its input in the production process 'The processing of food, beverages and tobacco and the manufacture of non-food products like textiles, wood products, furniture, leather, paper and rubber products absorb huge proportions of primary output' (Linneman et

al, 1987: p 189) So, the development in these industries will therefore increase indirect effects to the benefits of the primary sector Especially, these indirect impacts become so strong to employment since most industries in primary sector are labor-intensive ones

Figure 2.1: Employment and foreign exchange effects of export expansion

I Direct employment effect

Indirect employment effect

-Multiplier effects out ofincreased J spending

uOoooooooooooOOOOOOoooooooooooOOOOOOO oooooooo•OOOOOOOOoooooooo•••ooOOOOOOoooooo••••oo•oooooooooo•••••••••oooooooooO ••oooooooooooooooooooOOOOOOooo••••••oooooooOOoo•••o•ooOOOOOOoooo•••••ooOOOOOooooo••••ooooooooooooo••••••ooooooooooo••••ooooo

0

Foreign

exchange-effects : Output facilitating effects

Additional imports Additional imports for additional for intermediate

Increased consumption of import products

Imports of complementary intermediate ' '!' "1.&ct:::=== ,

-f L- _I_ , foreign exchange foreign

exchange receipts

• Balance of foreign J

after earnings from exports

increased spending Source: Linnemann et al, 1987: p186

22

Third, export expansion can help to release the constraint of foreign exchange The role of foreign exchange has just been mentioned in the two-gap model, which remains influential nowadays, with the identification that investment (and therefore growth) may be constrained

by either a shortage of domestic savings or a lack of foreign exchange When domestic savings are too small to finance the necessary level of investment for a projected growth (the saving-investment gap), the foreign capital can help to fulfill the lack In addition, lack of foreign exchange for imports is one of the three constraints of economic growth (Maizels, 1968) Linnemann et al (1987) also agree that export expansion can contribute to economic growth in developing countries by providing the foreign exchange for strategic imports as shown in figure 2.2 Through additional foreign exchange receipts, imports will increase for additional exports and for intermediate supply After balance between export earnings and spending on imports for additional exports and for intermediate supply, net exchange earnings from exports will continue to use for increased consumptions of import products and for imports of complementary intermediate (Linnemann et al., 1987)

Exports can bring to host countries large amount of foreign exchange, which is necessary for investment and re-investment For the case of developing countries when their currencies are not widely accepted in the world market and the desire of improving the economy is high, one problem arising is that the lack of foreign currency for imports of new technology So, exports will help to solve this problem in order to get faster economic growth by eliminating the foreign exchange constraint as the Thirlwall' s idea that foreign exchange used for imports

of capital goods, which cannot be produced domestically, is an important factor determining economic growth in developing countries (Thirlwall, 1994)

There are cases of some countries following import-substitution strategy with the problem of foreign exchange shortage They follow this trade strategy for a long time and their trade deficits increase gradually They have to borrow from abroad to finance the import demand,

and they become indebted for many years High debt can have bad effect on economic growth (Kagarol (2000), Were (2001) )

The above arguments have mentioned about the effect of exports on the demand side of the economy They include the direct effect of exports on GDP since it is part GDP; the multiplier effect and the linkage effects, and the effect to release the foreign exchange constraint

Effects of exports on savings and investment

Generally, exports are considered to have effect on savmgs Maizels has introduced an equation expressing the relation between exports and savings as following (Maizels, 1968: p69):

St =so+ s1Yt + (s2- SJ)Xt

Where St means savings at timet, so, s1, s2 are the marginal propensity to save at the time 0,

1, 2 respectively, and Xt is exports at time t

From the equation, it shows that beside total output, savings are dependent on the changes in exports between two years

The above equation is useful to show the effect of exports on savings However, it does not give a clear implication about the direction of effect since this direction is based on the marginal propensity to save between two years

Maizels adds that domestic savings would be likely to fluctuate with changes of exports There are two reasons leading to that situation First, the propensity to save in export sector may be higher than that in other sectors and second, movements in exports would result in movement in government revenues and these can affect the level of government investment (Maizels, 1968)

Others economists, as Milner (1990), and Meier (1994), have a clearer idea that export expansion may lead to higher savings This argument is reasonable since exports can increase

both household income and national income Exports make firms find opportunities to invest,

in turn government have to invest for satisfying the demand of export sector, and hence increasing the demand for investment, which leads to higher savings In addition, exports can bring an amount of foreign exchange to the government and the government can use part of them as their income for savings Exporters may have higher savings propensity, which in turn lead to higher investment Moreover, the multiplier effect, which increases production (or GDP), will increase the income and thus, savings as mentioned by Linnemann et al (1987)

Exports have effects on savings so, as a result, it has effects on investment since savings are sources of investment In his work, Sundrum states that the growth of exports will create profitable opportunities, which provide the demand for high rates of investment He also shows the example of developed countries in 1960s that 'the rapid growth of GDP in these countries was due to high and growing levels of investment, but these rate of investment were

in tum induced by the rapid growth of exports' (Sundrum, 1994: p117) Milner also agrees with this as he states that higher exports may finance greater investment (Milner, 1990)

Moreover, exports expansion can promote investment from abroad The above theories involving trade and FDI have mentioned partly the role of exports on attracting FDI Another argument is that most developing countries with small domestic market will not attract much FDI if exports do not solve the problem of the output So, export oriented economies is likely

to attract more FDI than those of import substitution economies Milner has stated that FDI into import substitution countries will be self-limiting in long run since they aim at the home market and therefore constrained by it (Milner, 1990) In turn, FDI improves the quality and quantity of domestic investment 'more significant in industries such as manufacturing which are crucial to development, and where local purchasing by TNCs provides a stimulant to local investment' (Bende-Nabende, 1999: p104)

Exports also contribute indirectly to investment through backward and forward linkages The diversification of exports can enhance linkages by dispersing exports production effects throughout the economy (Kasliwal, 1995) When one foreign enterprise is set up, it needs inputs from domestic or foreign market If domestic market can meet its demand, investment will be done for supplying these inputs Other linkages appear when this company consume its output such as packing, and transportation, and thus attract more investment

In conclusion, exports have effects on savings and thus directly, or indirectly on both domestic and foreign investment

Effects of exports on technological progress, human capital and productivity

Exports are considered to have positive effects on technology, human capital and thus to increase productivity

First, trade has been considered as the most important vehicle for the transmission of technological progress Exports can promote technological progress indirectly through imports and investment Exports may use their earnings to help host countries import directly technology to fulfill the need of modernizing the economies since in most countries; the abilities to invent new technology or to make a progress in technological research are small (Hansson, 1993) Moreover, technological progress might be larger fostered by exports via foreign investment Foreign investors often have large capital capacity so they can invest more on technological progress as well as technological research TNCs have an important role in the diffusion of technological innovation overseas by carrying it to the host countries (Bende-Nabende, 1999) So, higher rate of investment will lead to more rapid technological progress (Sundrum, 1994)

Empirical study ofPoapongsakorm and Tonguthai is consistent with these arguments In their empirical study of textile and electronics industries in Thailand, they state that exporters of these industries have acknowledged that they have to strengthen their technological

capabilities in order to sustain their growth as well as to keep their competitiveness in the fast changing economy (Poapongsakorm and Tonguthai, 1994) In addition, exports create link with foreign enterprises, which can provide technical assistance in quality control procedures, improving management access to newer technologies (Wieand Pangestu, 1998)

Second, exports enhance human capital through learning-by-doing process and investment in human capital Quality employment is trained in large number and they can serve as an important medium for the acquisition and dissemination of various kinds of technology through the inevitable labor mobility generated by investment (Ernst et al, 1998) Exports also have pressure for investors to maintain their competitive ability in markets and it lets 'most firms send their employees to training courses in management, technology and quality control, or some have organized in-house training' (Poapongsakorm and Tonguthai, 1994: p206) Domeland has found the similar conclusion when he does the research on US immigrants In his work, he found that trade has increased human capital accumulation (Domeland, 2002)

Last, productivity growth is a result of technological progress and improvement in human capital A rapid growth of productivity cannot be explained solely by the capital accumulation, much of it must be the result of a high rate of technological progress (Sundrum, 1994) Improvement in human capital can impart 'a variety of skills and knowledge that would potentially useful on the job, ranging from specific skills like computer programming and accounting to general skills like reasoning ability, writing skills, and proficiency in solving mathematical problems' (Blau and Ferber, 1992: p148) Wagner (2001) and Girma et al (2002) also agree that export expansion has positive effect on productivity growth 'Empirical evidence shows that technology transfer to developing countries has a beneficial impact on growth through increased productivity of factors of

production, i.e improving the efficiency of labor-intensive in the process of production' (Ben de-N abende, 1999: p 1 00-1)

So, it can be said that exports or export expansion stimulate technological progress, human capital, and thus productivity

In conclusion, this part has presented the effects of exports on growth This has examined a number of channels through which exports can have impacts on growth Through the effect

on demand of the economy; effects on savings, and thus investment; and through technological progress, human capital and productivity, export expansion has affected on growth

11.3 EMPIRICAL STUDIES

There are many empirical studies investigating determinants of economic growth internationally, some emphasis on the role of exports as a determinant of growth Some examine cross-national data as Gylfason (1998) for all 160 countries, or Sheeney (1992) for fifty-three developing countries, while others do domestically as Al-Yousif (1992) for Malaysia annual data, Nigudala (1994) for India annual data, and Sun and Parikh (1996) for panel data of twenty-nine provinces in China, etc The results are quite differently While some show the positive effect of export growth on economic growth such as studies of Sun and Parikh (1996), Al-Yousif (1992), Lloyd, Morrissey, and Osei (2001), Nigugala (1999), others have negative or insignificant results such as studies of Gylfason (1998), Sheeney (1992), and Siddique and Selvanathan (1998) Following, each of these empirical studies will

be presented for more details

11.3.1 Study of H Sun and A Parikh (1996)

The paper studies the effects of determinants such as export growth, change in export as a share of GDP, domestic investment and foreign investment as a share of GDP on GDP growth rate (Sun and Parikh, 1996) All variables are measured as the growth rate The labor

growth is also a determinant but it is statistically insignificant in all regressions The data used are panel data coming from 29 provinces across three main regions in China from 1985-

1995 and they are at constant 1984 price

They first run single equations and find that the externality effect of export and non-export sectors is positive and strong, and it is statistically significant at 10% In addition, the regression results show that besides export, the provincial GDP growth is largely due to domestic and foreign investment

Then, they run simultaneous equations to avoid the simultaneous bias The first equation uses GDP as dependent variable while export, domestic investment, and foreign investment are explanatory variables The second equation uses export as dependent variable, and GDP, two dummies, region1 and region2 for coastal and non-coastal regions, are independent variable

In the first model, the two explanatory investment variables are not statistically significant as well as the two dummies in the second model However, there is a significant relationship between export growth and economic growth in the second equation This shows that export growth is largely explained by GDP growth (Sun and Parikh, 1996: p 11 )

In conclusion, the paper has investigated the impacts of export growth as well as the investment factors on GDP growth It has found that exports have generally a positive and significant effect on Chinese economic growth Domestic and foreign investments also have strong impact on growth (Sun and Parikh, 1996: p14)

11.3.2 Study ofY A Al-Yousif(1999)

AI-Yousif re-examines the relationship between exports and economic growth in Malaysian context using a multivariate model and the time series are used, covering the period 1955-

1996

In the model, the author uses five variables: real GDP, real exports, the employment index to represent labor, real gross fixed capital, and the real effective exchange rate of Malaysian Ringgit per USD

He first shows that the results are reliable and unbiased by proving the stationary data Then,

he uses the Johansen Method to test the co-integration among variables This test includes two stages In the first stage, the test is performed on the bivariate model to see whether the two basic variables, exports and output, are co-integrated, and he finds that these two variables are not co-integrated However, when the bivariate model is expanded into a multivariate context, the results are different They indicate the existence of one non-zero stable co-integrating vector linking the two variables with the other three variables in the model (Al-Yousif, 1999: p69)

He, next, uses Granger causality inferences by specifying an equation for each of the five variables by mean of Akaike's final prediction error criterion Five equations are then pooled and estimated as a vector-error-correction model (VECM) using Zellner's seemingly unrelated regression (SUR) method (Al-Yousif, 1999: p70) The results ofVECM show that the export-led growth hypothesis is supported by the Malaysian data in short-run process and exports tend to growth in response to a growing economy in the long run Three others including labor, capital, and the exchange rate also play an important role in determining real output growth in Malaysia

To sum up, the author has found that five variables in the model are co-integrated and thus have a long run relationship The results from the multivariate model indicate one non-zero integrating relationship between export growth and economic growth in Malaysia One more important finding is that real exports exert unidirectional impact on real output in the short-run, but in long run this influence seems to die out Over the long run, the result suggests that

economic growth in Malaysia appears to have been the outcome of non-export factors such as technical progress and the accumulation ofbusiness skills (Al-Yousif, 1999: p73)

11.3.3 Study ofT Lloyd, 0 Morrissey, and R Osei (2001)

The authors investigate the impact of export growth on economic growth in a work entitled 'Aid, Exports and Growth in Ghana' in 2001 First, they use Augmented Dickey Fuller (ADF) test, in which they use government consumption, exports, foreign aid, central government investment, and private investment as explanatory variables and private consumption as proxy of real GDP is dependent variable All variables are in natural log and data are in constant US dollar (1985=100) covering the period 1970 to 1997

However, to eliminate the shortcoming of the ADF test - inability to clearly distinguish between deterministed and stochastic trends (Lloyd et al., 2001: p14) - they use long-run estimates and co-integration tests, additionally For this one, they also use private consumption as dependent variable, exports, trend, government investment, and foreign aid

as explanatory variables

For both models of test, the result is similar for all studying period: exports, foreign aid, and government investment have a positive effect on private consumption, and the last two determinants make a greater contribution to private consumption growth

However, when the authors divide the period into two sub-periods: pre-1983 and ex-1983, the results are quite different In pre-1983, expansion of exports and government investment are inimical to growth while changes in export earnings have an enhanced effect on growth and the coefficient on aid growth is insignificant (Lloyd et al., 2001: p 16-20) However, for post-

1983 period, all three main variables positively contribute to growth

Another finding is that there is no evidence that private investment has any significant effect

on growth (the variable is insignificant in all regressions)