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IMPACT OF TRADE LIBERALISATION ON ECONOMIC GROWTH IN GHANA

BY

ABUBAKARI ZAKARI (Consultant on Trade and Industrial Policy, Private Sector Development and MSEs)

ADDRESS: P. O. Box AT1364 Achimota, Accra Tel: +233 244796541 E-mail: zack792003@yahoo.co.uk

JUNE, 2012

i


DECLARATION I, Abubakari Zakari, hereby declare that this study is entirely my research work effort, and except for references to other researches (published and unpublished) which have been duly acknowledged in this study.

ii


ABSTRACT Openness to trade has been put forward as a means to achieving economic growth. Studies have shown that free trade is better than no trade and therefore trade liberalisation will significantly improve export earnings and enhance economic growth. Many countries especially those of South-East Asia have attained significant growth rates which are partly attributed to their trade policies. Although trade liberalisation has benefited some countries, the same cannot be said of many African countries, including Ghana; a situation attributed to the fact that trade reforms tend to generate both winners and losers. Thus, the impact of trade liberalisation on economic growth may not necessarily be unambiguous. Ghana has liberalised its economy since the earlier 1980s. The broad objective of the study is to analyse the impact of the trade liberalisation on economic growth in Ghana from 1984 to 2011. The specific objectives are to examine the trends of liberalisation and GDP growth rate over the period 1984 to 2011, to examine the relationship between trade openness and economic growth. The study finds that the economy suffered in the mid 1980s since it experienced negative growth rates in some years though it responded positively from 1985 onwards. The relatively high levels of trade liberalisation are associated with higher real GDP growth and for that matter economic growth. The economic variables share a long-run equilibrium relationship implying that over long period of time the variables will not move independently of each other but rather are linked in the long-run. Trade liberalisation in the long run can be the engine that encourages competitiveness and efficiency in both domestic and international markets. It is recommended that trade liberalisation policy implementation should be encouraged in order to get the long run benefit to the economy. Ghana’s growth objective through export-led growth is likely to be effective because in the long run trade liberalisation would be favourable. Thus Export promotion should be highly intensified as part of the trade liberalisation policy. There should also be diversification of our exports in terms of the base and adding value to the existing ones as well as expanding market destinations.

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TABLE OF CONTENTS CONTENTS

PAGE

DECLARATION …………………………………………………………………….

i

ABSTRACT ………………………………………………………………………..

ii

LIST OF TABLES ……………………………………………………………………

iii

LIST OF FIGURES …………………………………………………………………..

iv

LIST OF ABBREVIATIONS AND ACRONYMS

v

CHAPTER ONE ……………………………………………………………………..

1

INTRODUCTION ……………………………………………………………………

1

1.1 Background of the Study ……………………………….…………………………

1

1.2 Statement of problems ………….. ………………………..……………………..

3

1.3 Objectives of the study ..................…..………………...…………………………

4

1.4 Research hypothesis .................................................................................................

5

1.5 Relevance/Significance for the Study ...…………………………….…………….

5

1.6 Organisation of the Study ....………………………………………………………

6

CHAPTER TWO ………………………………………………………………….

7

OVERVIEW OF TRADE LIBERALISATION AND ECONOMIC GROWTH IN GHANA......................... ……………………………...

7

2.1 Introduction ……………………………………………………………………..

7

2.2 History of Trade Liberalisation in Ghana............................................................

7

2.3 Trade Regime and Economic Growth ...................................................................

9

2.4 Trade Liberalisation and Balance of Payments …………………………………..

12

iv


2.5 Trade Regimes and Employment..........................................................................

15

2.6 Liberalisation, Poverty and Income Distribution..................................................

19

2.7 Conclusion ....................................………………………………………………

22

CHAPTER THREE ………………………………………………………………....

25

THEORETICAL AND EMPIRICAL LITERATURE REVIEW..………………. ..

25

3.1 Introduction ………………………………………………………………………

25

3.2 Theoretical Literature ...........……………………………………………………..

25

3.2.1 Theories of economic growth......................................................................... .

25

3.2.2 Theory of trade liberalisation........................................................................... .

31

3.3 Empirical Literature ...................................................................…………………

35

3.4 Concluding Remarks on Literature ................……………………………………

38

CHAPTER FOUR ………………………………………………………………….

40

METHODOLOGY AND DISCUSSION OF FINDINGS .............................…….. ..

40

4.1 Introduction ………………………………………………………………………

40

4.2 Method of Analysis and Theoretical Framework for the model specification.......

40

4.2.1 Method of Analysis .................................………………………………………

40

4.2.2 Theoretical Framework.........................................................................................

41

4.2.3 Model Specification …………………………………………………………….

42

4.3 Description of Variables of the Model and Data Source ........................................

44

4.4 Trends of Trade Liberalisation and Economic Growth...………………………...

46

4.5 The Time Series Properties of the Variables ……………………………………..

48

4.5.1 Unit root test …………………………………………………………………….

48

4.5.2 Co-integration test ………………………………………………………………

52

4.6 Analysis of findings of the regression results ……….............................................

54

v


4.6.1 Long Run Growth Relationship of Cointegration Equation.................................

54

4.6.2 Short run Growth and Error Correction Model (ECM)......................................

57

4.7 Causality test between Trade Openness and Economic Growth.............................

60

CHAPTER FIVE ……………………………………………………………………...

63

SUMMARY AND CONCLUSION AND POLICY RECOMMENDATIONS..............

63

5.1 Summary and Conclusion...…………………………………………………………

63

5.2 Policy recommendations ……………………………………..................................

66

REFERENCES........................................................................................................ ......

70

vi


LIST OF TABLES Table 2.1: Sectoral Contribution to Real GDP in percentage (Period Averages)………

11

Table 2.2: Percentage Growth in Industry (2003-2006)………………………………..

12

Table 2.3: FDI Inflows through the GIPC (million US $)………………………………

18

Table 4.1: Result of ADF Unit Root Test of variables at their levels..............................

49

Table 4.2: Result of ADF Unit Root Test of variables at their difference......................

49

Table 4.3: Results of Philip-Perron Unit Root Test of variables at their levels...............

50

Table 4.4: Results of Philip-Perron Unit Root Test of variables at their difference.......

50

Table 4.5: Results of Johansen co-integration test..........................................................

53

Table 4.6: Results of the long-run Coefficients of Cointegration Equation....................

55

Table 4.7: Results of Error Correction Model (ECM).....................................................

58

Table 4.8: Correlation Matrix for the Variables...............................................................

61

Table 4.9: Results of Pairwise Granger Causality Tests................................................

62

vii


LIST OF FIGURES Figure 4.1: Trends of Trade Liberalisation and Economic Growth 1984 to 2011……..

viii

47


LIST OF ABBREVIATIONS AND ACRONYMS ADF

-

Augmented Dickey-Fuller

BOP

-

balance of payments

ECM

-

Error Correction Model

ECOWAS

-

Economic Community of West African States

EPZs

-

Export Processing Zones

ERP

-

Economic Recovery Programme

FDI

-

Foreign Direct Investment

GATT

-

General Agreement on Tariff and Trade

GDP

-

Gross Domestic Products

GIPC

-

Ghana Investment Promotion Centre

GLSS

-

Ghana Living Standard Survey

GMM

-

Generalize Method of Movement

IMF

-

International Monetary Fund

ISI

-

Import Substitution Industrialization

ISSER

-

Institute of Statistical, Social and Economic Research

MNC

-

Multinational Corporation

MoFEP

-

Ministry of Finance and Economic Planning

NIE

-

New Institutional Economics

NTB

-

Non- Tariff Barriers

OGL

-

Open General Licence

OLS

-

Ordinary Least Square

PP

-

Phillip-Perron

ix


R&D

-

Research and Development

R

2

-

Correlation coefficient of determination

TFP

-

Total Factor Productivity

VECM

-

Vector Error Correction Model

WTO

-

World Trade Organisation

x


CHAPTER ONE INTRODUCTION 1.1

Background to the Study Ever since the classical works of absolute advantage by Adam Smith and comparative advantage by David Ricardo, economists have focused attention on international trade. Openness to trade has been put forward as a means to achieving economic growth. According to Alfred Marshall (1890), the causes which determine the economic progress of nations belong to the study of international trade. Studies have shown that free trade is better than no trade and therefore trade liberalization will significantly improve export earnings and enhance economic growth. Some of these studies include Edwards (1998), Yanikkaya (2003), Ahmed, Y. and Anoruo, E. (2000), Sachs and Warner (1997), Harrison (1996), Iscan, T. (1998), Paulino (2002) and Wacziarg (2001).

Many countries especially those of South-East Asia have attained significant growth rates which are partly attributed to their trade policies. Evidence from countries such as India and China also show that economic growth has led to significant declines in poverty levels. Many African countries including Ghana have liberalized their trade regimes by reducing trade barriers and encouraged export processing companies. Although trade liberalisation has benefited some countries (e.g. South-East Asian countries), the same cannot be said of many African countries, including Ghana; a situation attributed to the fact that trade reforms tend to generate both winners and losers. Thus, the impact of trade liberalisation on economic growth may not necessarily be unambiguous.

1


Since independence in 1957, Ghana followed import substitution strategy and applied different methods of restrictive trade policies which include increase in import tariffs, non-tariffs barriers and exchange rate controls until liberalization period in 1986. The exchange rate was fixed while import quantities were strictly controlled through the Bank of Ghana foreign-exchange allocations (Armah, 1993). Between 1970 and 1982, both import volumes and import to GDP ratio registered continuous declines and the trend in the export/GDP ratio and the export volume index was downward. The ratio of export to GDP declined from 20.7 to 3.6 whilst ratio of import to GDP declined from 18.5 to 3.3 (World Bank, 1995). Also, Ghana’s economy experienced negative growth rate for some of the years especially negative 12.9% in 1975, negative 3.5% in 1976, negative 7.8% in 1979 and negative 4.6% in 1983 (ISSER, 2000).

The dominant economic idea however, is how far liberalization of trade enhances the drive to rapid economic growth. It is recognized that the extent of trade liberalization differs among groups of countries and countries in the same group due to structural and economic peculiarities. Thus, a specific country analysis of the trade liberalization is justified to give a better understanding of its (i.e. trade liberalization) impact on GDP growth in individual countries.

1.2

Statement of the Problems 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 (Yanikkaya, 2003). Theoretical growth studies (e.g. Romer, 1990; Grossman and Helpman, 1990) 2


suggest at best a very complex and ambiguous relationship between trade restrictions and growth. The endogenous growth literature has been diverse enough to provide a different array of models in which trade restrictions can decrease or increase the worldwide rate of growth (see Romer, 1990; Grossman and Helpman, 1990; Rivera-Batiz and Romer, 1991; Matsuyama, 1992).

The impact of trade liberation on economic growth has been the subject of many discussions and studies over several decades. This can be evidenced from many World Trade Organisation (WTO) agreements including the General Agreement on Tariffs and Trade (GATT). In 1986, Ghana adopted the policy of trade liberalization as part of the reform and adjustment programmes of the Breton Wood Institutions. The objective was to open the economy to competition to enhance efficiency in domestic production which would eventually lead to growth in output, reduce the high incidence of balance of payment deficits and consequently enhance GDP growth. The adoption of the trade liberalization policy was also in response to the poor performance of the external trade sector.

Even though, trade liberalisation in Ghana led to economic growth, the impact was not much due to slow growth of the supply side of the economy especially, the manufacturing sector. During the liberalization period, import volumes have increased continuously. The volume of imports increased from US$712.5 million in 1986 (representing 12.43% of GDP) to US$1,728.0 million in 1993 also representing 28.51% of GDP. This was partly due to trade liberalization releasing pent-up demand. But it was also due to positive income growth rates and large capital inflows. The decline in the 3


anti-export bias of the trade and payment regime has led to increases in export volumes particularly in the traditional sectors of cocoa, gold and timber, although there has been little in the way of export diversification. The volume of exports also rose from US$773.4 million in 1986 to US$1,234.70 million in 1994 representing 13.49% of GDP and 22.63% of GDP respectively.

There is the need to investigate the impact of trade liberalization on Ghana’s economy through examination of the trends in real trade balance, openness of trade and GDP growth in Ghana. This leads to the question, what has been the impact of trade liberalization on the economy of Ghana since 1985?

1.3

Objective of the Study The broad objective of the study is to analyse the impact of the trade liberalization on economic growth in Ghana from 1980 to 2011. The specific objectives are: i.

To examine the trends of liberalization and GDP growth rate over the period 1980 to 2011

ii.

To examine the relationship between trade liberalisation (openness) and economic growth

1.4

Research Hypothesis Consistent with the research objectives, the study will test and validate the following empirical hypothesis: H0: Trade openness does not enhance economic growth. 4


H1: Trade openness enhances economic growth.

1.5

Relevance/Significance for the Study The target of every economy is to attain the highest possible level of growth. A rise in growth usually implies a rise in the aggregate welfare of the people. For this reason, governments of developing countries over the years have been pursuing policies that would lead to growth. Obviously, international trade theory as well as empirical evidence from the South-East Asia has shown that trade liberalization and for that matter trade openness has a positive correlation with economic growth. Ghana made an early attempt at trade liberalization between 1966 and 1972 which was not successful. However, the policy was again adopted as part of the Economic Recovery Programme (ERP) in 1983 but came into full effect in 1986 with the abolition of all quantitative controls on imports and exports as well as the liberalization of the exchange rate regime.

The study is relevant in the sense that it focuses on measuring the effects of liberalisation on economic growth in Ghana. This will help policy makers to maximise the benefits of trade and foreign direct investment and to take advantage of trade openness to increase growth. The study also contributes to the empirical literature of the relationship between trade openness and economic growth in Ghana.

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1.6

Organisation of the Study The study is organised into five main chapters. The first chapter was the introduction which involves background of the study, statement of problems, objectives of the study, research hypothesis, relevance/justification of the study and organisation of the study. Chapter two deals with the overview of trade liberalisation and economic growth in Ghana. Chapter three discusses the theoretical and empirical literature on liberalisation and economic growth and make concluding remark on the literature.

Chapter four discusses the methodology and analysis of finding which involve method of data analysis, theoretical framework, model specification, description of variables and the presentation of analysis and discussion of results. Then finally, chapter five provide the summary and conclusions, and policy recommendations.

6


CHAPTER TWO OVERVIEW OF TRADE LIBERALISATION AND ECONOMIC GROWTH IN GHANA 2.1

Introduction This chapter deals with the overview of Ghana’s economy emphasizing on the trade liberalisation and economic growth. The rest of the chapter is arranged as follows: section 2.2 deals with history of trade liberalisation in Ghana, section 2.3 is the review of trade regime and economic growth, section 2.4 discusses trade liberalization and balance of payments, section 2.5 considers the trade regimes and employment whilst section 2.6 deals with the trade liberalisation, poverty and income distribution and the last section 2.7 is the conclusion.

2.2

History of Trade Liberalisation in Ghana Economic growth as a means of achieving high living standards has long been one of the primary objectives of Ghanaian policy. Attention has repeatedly been focused on measures to accelerate economic growth. A significant manifestation of this emphasis has been a series of development plans dating back to the 1920's. With the attainment of independence in 1957, planning for growth and development was given a renewed emphasis and the preparation of a five year plan began. In July 1967 the government of Ghana chose to devalue and launch the economy on an experiment with import liberalization (Killick, 2010). Conventional wisdom, based largely on structuralist elasticity pessimism, continued to oppose devaluation as a means of achieving external balance. Yet the corruption of the late Nkrumah era, together with the severe austerity imposed on the post-coup economy for balance-of-payments reasons, combined to produce substantial dissatisfaction with the existing system as a long-term solution. 7


A major body of domestic opinion, mostly the new commercial and industrial uppermiddle class, viewed controls and austerity as undesirable, and an import liberalization as a means of discarding both. There was a general recognition that no significant liberalization could be achieved without devaluation. However, there was little recognition that control over aggregate demand would be more urgent in a liberalized system (Leith, 1974). Four and one-half years later the liberalization had collapsed (Killick, 2010). Between 1972 and 1982, trade policy in Ghana was characterized by strict import controls. The major features of this regime included the revaluation of the domestic currency by 26%, resort to import controls including use of import licences as the main instrument, and the maintenance of exchange controls. Others were the wide variations in import duties and frequent changes in import taxes aimed basically at revenue generation. These wide variations in import duties made tax evasion possible through misclassification of imported goods (Insaidoo-Obeng, 2008). The licencing system for 1972 was as restrictive as the system of a decade earlier (Killick, 2010).

By 1977, it was recognized that the strict import control system contributed to the economic problems facing the manufacturing sector. It was therefore decided that restrictions on the importation of raw materials and spare parts for some of the large enterprises within defined industries would be lifted. The industries identified to benefit from the liberalization scheme were food processing, poultry, beverages, soaps and detergents,

textiles

agricultural

machinery

and

implements,

pharmaceuticals,

transportation and household goods (Jebuni, Oduro and Tutu, 1994). Thus, the resort to trade reforms after 1982 with the long-term goal of replacing quantitative restrictions 8


with price instruments and creating a liberal trade regime was most welcome (InsaidooObeng, 2008).

2.3

Trade Regime and Economic Growth The extent to which trade openness and foreign aid impacts on economic growth, has for years been an issue of global debate. Being one of the forerunners to adopt liberalisation policies in sub-Saharan Africa, Ghana’s post-liberalisation economic growth performance has received commendations from international institutions. This has increased government commitment in recent years to open the economy to international competition. There was significant and steady growth of the economy following reforms that began in 1983. This has averaged 4.5% in the last two decades. Aryeetey and Tarp (2000) have argued that the growth of the 1980s came about as a result of the expansion of public investment, largely as a consequence of increased aid flows. This expansion has been compared to the expansion that occurred in the 1960s financed largely by running down reserves. In both cases the increased use of capital was not complemented with significant improvements in total factor productivity. Again, in both instances, the injection of capital came after long periods of relatively high capital depreciation (Aryeetey, 2005).

However, Ghana witnessed poor economic growth performance as a result of the liberalisation. Although the highest economic growth performance (after independence in March 1957 and before liberalization policies in 1983) of 7.2% occurred in 1970, economic growth performance for most periods was poor. For example, the years 1964 to 1966, 1968, 1972 to 1973, 1975 to 1976, and 1979 to 1983, saw Ghana with negative real 9


GDP per capita growth with the lowest of -14.5% occurring in 1975 (Sakyi, 2010). This result was mainly due to the adoption of import substitution industrialisation (ISI) policies coupled with successive political instability, disinvestment, total factor productivity slowdown, and the deep economic crisis that occurred in the mid-1970s.

Moreover, there were conflicts in policy objectives and a number of trade control regimes and instruments (high tariffs, stringent quota restrictions, export restrictions, foreignexchange restrictions, and high black-market premium) that resulted in exchange rate and balance of payment problems. For instance, it was expected that a policy to expand the manufacturing base through ISI would automatically be accompanied by an increase in manufactured exports (and therefore a diversification of export) supported by an effective export promotion package (Aryeetey et al., 2000). Unfortunately, the export incentive package was ineffective resulting in drastic decline in export performance. The conclusion that can be drawn from the poor performance of the economy is that, the policies implemented were inappropriate and inadequate (Sakyi, 2010).

Despite the positive growth rates of the last two decades, there is hardly any evidence of significant structural change in the economy. This is the situation in spite of the fact that data on sectoral GDP shares in Table 2.1 below suggest an earlier declining share of industry and agriculture in total output and a growing share of services in GDP. After a period of services dominating GDP and its growth, the agricultural sector is beginning to re-assert itself as the dominant sector of the economy. It is also important to underscore the fact that much of the earlier growth of services was derived from the relatively lower-

10


order service sectors, notably wholesale and retail trade, and also restaurants and hotels (Aryeetey and Fosu, 2003). Table 2.1: Sectoral Contribution to Real GDP in percentage (Period Averages) Sector

1970-75 1976-82 1983-86 1987-90 1991-95 1995-00 2000-04

Agriculture

52

51

52

46

42

40

42

Industry

19

17

12

14

14

27

26

Services

29

32

36

40

44

33

34

Source: Aryeetey (2005), Calculated from Ghana Statistical Services data

The shares of mining and construction in GDP in Table 2.2 have also increased in recent times, but that of manufacturing has not especially in 2006 as it recorded 4.2%. Mining and quarrying experienced relative increase in 2005. These changes are not suggestive of structural transformation. Growth in savings and investment remain slow as well. So far the level of domestic savings as a percentage of GDP has generally been below 8%. Although there is a definite upward trend since the dismal levels of the early 1990s, much higher levels are required for any sustained growth in investment and GDP (Aryeetey, 2005). Table 2.2: Percentage Growth in Industry (2003-2006) Activity

2003

2004

2005

2006

Industry

5.1

4.8

7.7

7.3

Mining and Quarrying

4.7

3.0

6.3

3.0

Manufacturing

4.6

4.6

5.0

4.2

Electricity and Water

4.2

3.7

12.4

23.0

11


Construction

6.1

6.6

10.0

8.2

Source: Ghana Statistical Service/MoFEP

2.4

Trade Liberalization and Balance of Payments In spite of the deteriorating balance of payments and fiscal deficit situation, the government launched the seven-year development plan in 1963-64. This, as with the second five-year development plan, involved massive government expenditures to boost the import substitution industrialization effort. With the government refusing to accept an IMF/World Bank stabilization package involving devaluation, it had to resort to everincreasing trade restrictions to control the balance of payments and provide protection for domestic industry. This culminated in increasing pressure on the system resulting in rampant abuse and corruption. With seriously depleted foreign exchange reserves, the government resorted to increased borrowing abroad. Between 1966 and 1967, Ghana entered Phase III of the controlled regime. The new government accepted the IMF/World Bank stabilization package and trying to stabilize the economy and getting inflation under control by using both deflationary fiscal and monetary policies and decontrolling state production. The system for allocating import licenses was altered to ensure efficient mobilization of domestic resources and adequate supplies of essential commodities for consumers (Leith, 1974).

The balance of payments (BOP) situation remained precarious. The external trade sector has also experienced only marginal changes in the last forty years, with the composition of exports hardly altered, until very recently. The share of exports in GDP declined significantly from the late 1960s until the early 1980s, and this can be associated with a 12


sharp decline and disinvestment in the cocoa sector and a strong anti-export bias in policies (Oduro, 2000). There was considerable dissatisfaction with the rigid controls and macroeconomic austerity. There was also concern over the effect that rising expectations of possible changes in the exchange rate was having on potential foreign investment and a realization that donor assistance was unlikely until Ghana corrected its balance of payments. Rescheduling medium term debt provided some immediate relief but not a long term solution. July 1967 saw the beginning of a liberalized import regime which was maintained until 1971. In July 1967, the currency was devalued by 43%, import duties were lowered on some selected essential commodities and the government committed itself to liberalizing imports over the next four years.

However, in view of increasing urban unrest, the restrictive macroeconomic policies could not be maintained. The liberalization therefore occurred with expansionary fiscal and monetary policies. Liberalization policies were continued by the civilian government which took over in 1969. As they occurred in the absence of restrictive macroeconomic policies, pressure was put on the trade balance, but this was masked by high world cocoa prices, foreign aid inflows and some debt relief. Cocoa prices rose from US$379 per tonne in 1965 to US$1,108 in 1969. The government took advantage of high world market prices for cocoa in 1970 to permit a rapid expansion of expenditures and imports through the Open General Licence (OGL). This increased the balance of payments deficit.

With accelerating inflation eating away at the devaluation of 1967, the real effective exchange rate on imports appreciated at the same time that the imports regime was being 13


liberalized. With a substantial government deficit budgeted for 1971-72, upward pressure in prices seemed likely to erode import taxes and export subsidies. With a sharp drop in cocoa prices from US$997 in 1969 to US$565 in 1971, the trade account went into deficit. Foreign exchange reserves at the end of the third quarter of 1971 were less than half the trade deficit over the first three-quarters of that year. On 27 th December 1971 the currency was devalued. The government urgently needed foreign inflows to ease the foreign exchange constraint. However, any support from the international community was conditional upon strict macroeconomic policies including devaluation. In addition to the 44% devaluation, government expenditures were cut, and import taxes were increased. Prices of most consumer items increased substantially, and these prompted a military coup on 13th January 1972 (Jebuni, Oduru and Tutu, 1994).

Since 1960 there has been an overall deficit in Ghana’s external payments as well as current account. The balance of trade and current account were negative at GH¢10 million and GH¢129 million respectively whilst overall balance of payments was negative GH¢70 million. This worsened in 1961 as the economy recorded negative GH¢72 million balance of trade and GH¢203 million current account whilst overall balance of payments was negative GH¢219 million. There was a balanced trade in 1964 as imports and export became equal and this relieved current account to negative GH¢130 million. The balance of payment problems encountered by Ghana was mainly due to the net invisible which includes the transfer payment (Killick, 2010).

Larger-than-normal inflows of foreign exchange from the pre-financing of the cocoa crop contributed to the rebuilding of international reserves and an associated acceleration in 14


money growth in the fourth quarter of 2002. Gross international reserves recovered to nearly two months of imports despite a substantial shortfall in external program support – loans and grants. Ghana’s medium term plans for the reform of its tariff regime are bound up with those of ECOWAS, the members of which “have yet to agree on a time table for the next phase of tariff reforms”. The only major change in the trade regime over the last two years has been the abolition in July 2002 of the special import tax (Abbey, 2003).

2.5

Trade Regimes and Employment One of the most interesting issues that have come out from Ghana’s reform effort has been the rather slow growth of formal employment. This has often been linked to the slow growth in investment and the absence of employment generating investment. In particular, there have been questions about the areas in which the opening up of trade has occurred, and about the magnitude and type of foreign direct investment (FDI) that has supported production in the period. The policies for increased openness include those on trade, foreign exchange transfers, tourism promotion, investment promotion, export promotion, tax incentives, and promotion of private business through privatisation of state-owned enterprises. It is not clear how they have influenced employment trends in Ghana in view of the paucity of data.

Employment increased from 208,000 in 1981 to 464,000 in 1985 after which it decreased up to 1991. According to Aryeetey (2005), the formal sector by industrial activities indicate the Agriculture, Hunting, Forestry and Fishing generated 54,900 employments in 1980 forming 16.3% of jobs created by formal sector which increased to 56,400 in 1985 forming 12.1% of jobs created by formal sector. Formal employment decreased to 14,700 15


constituting 7.9% of the formal jobs in 1991. In terms of Industrial sector, 87,900 employments were generated making 26.1% of formal jobs in 1980 whilst 108,100 (23.3%) and 47,200 (25.3%) were generated respectively in 1985 and 1991. While employment within the EPZs increased over the period 1996-2002, it is important to establish the robustness of this observation. A cumulative total of 37,145 jobs were created through the Export Processing Zones for 1995-2003, while 1,692 jobs were created through export-oriented companies registered through the GIPC by 2002 (Aryeetey, 2005).

It may be expected that in general an increase in FDI will lead to an increase in labour demand. Depending on the way multinational corporations with FDI operate, the outcomes on employment may vary. First, they may locate in a country to pursue importsubstituting production to take advantage of trade protection. In this case they produce import-competing goods, which are more capital and/or skilled labour intensive than those of domestic export-oriented enterprises. As such their activities in a Least Developed Country may not have a significant effect on the labour market since they would employ fewer workers per unit of investment than similar domestic firms (Grieco, 1985). The second type of multinational corporation (MNC) activity may be to produce goods almost solely for export, possibly in an Export Processing Zone. In this case, competitive pressures force them to employ the lowest-cost techniques, which invariably mean labour-intensive production. The inflow of FDI in this case leads to increased demand for labour, particularly unskilled workers.

16


The Ghana Investment Promotion Centre suggests that FDI has had some positive effect on total formal employment, as well as the quality and skill levels of Ghanaian workers. The centre reports that about 74 % of enterprises registered since 1994 are in operation, and that FDI inflows registered for 1995-2002 cumulatively amounted to $150 million. The peak for FDI inflows registered at GIPC was almost $475 million in 1997 (refer to Table 2.3. These FDI inflows have created a cumulative total of 76,350 jobs for the period 1995-2002 out of which 71,635 were for Ghanaians. The cumulative figure up to year 2000 was 60,276 Ghanaian jobs representing 0.7% of the economically active population from the 2000 census (GIPC, 2004).

Table 2.3: FDI Inflows through the GIPC (million US $) Year

1995

1997

1998

1999

2000

2001

2002

94.88 137.29

44.27

45.53

38.77

32.58

19.49

101.2 100.02 337.29 112.38 181.18

76.14

56.73

39.44

150.27 194.9 474.58 156.65 226.71 114.91 89.32

58.93

Foreign Equity 49.07 Foreign Loan Total

1996

Source: GIPC Investment Report (various issues).

The issue of foreign ownership and firm performance was studied by Ramachandran and Shah (1998) for Ghana, also using Regional Program on Enterprise Development data. They found that the value added per worker increases consistently with the increasing share of foreign ownership. Ultimately wholly foreign owned firms have the highest value added per worker. However, between firms with foreign ownership at 55%- 65% and the next category there is a sharp drop of 47.4% in the total number of workers per firm. This suggests that some labour saving occurs. As foreign ownership increases the 17


firm size displays an inverted U-shape. Shah (1998) showed that firms in which foreign ownership exceeds 55% are more likely to upgrade the skills of their workers. The number of firms with training programmes increases with the degree of foreign ownership.

Biggs et al (1995) calculated factor intensities and productivities for Ghana. They note that generally the capital intensity rises with firm size, but the jump between firms with 5 - 9 workers and those with 10-19 workers is in the magnitude of about 500% which suggests a structural break in capital intensity. Firms of size 50-99 workers are the most labour intensive (or least capital intensive). When compared with Kenya and Zimbabwe, Ghanaian firms with 100-199 workers have the highest labour intensities for that category.

Despite the revival of the export sector, most Ghanaians continued to find employment with the government or to rely on informal employment for their livelihood. According to Aryeetey (2005), an increasing number of Ghanaians turned to smuggling or to crime to earn a living. Reductions in the number of government workers had not been absorbed in the export sector by the early 1990s. At the same time, wages had not kept up with the cost of living. Gorg and Strobl (2002), using firm-level data on manufacturing in Ghana, found that skill-biased technical change, arising from increased purchase of foreign machinery after the trade reforms, resulted in increased demand for skilled workers. However, to the extent that skill-biased technological change is an endogenous product of trade liberalisation, the relative non-performance of unskilled rural and food crop farming households could be attributed, at least partially or indirectly, to trade liberalisation. 18


Moreover, Teal (1999, 2001), using firm-level and household data respectively, finds no evidence of any underlying technical progress in explaining the increased income inequality in the 1990s.

2.6

Trade Liberalisation, Poverty and Income Distribution The relationship between trade liberalisation and poverty has attracted a lot of attention in development economics. The theoretic argument which has formed the basis of economic reform programmes is that trade liberalisation spurs on economic growth and therefore should alleviate poverty (Dollar and Kraay, 2001). The assumption is that liberalisation impact households through the intermediary of product and factor markets. It is also asserted that trade reforms and its associated shocks trickle down to households indirectly via fiscal policy instruments. Through disbursements of government revenue for social services and infrastructure poor households are ultimately affected (Winters, 2000; Niimi et al, 2003).

Ghana is one of the few countries in Sub-Saharan Africa that has been described as fast liberalizers because of the pace and extent at which trade liberalisation was carried out. Although Ghana’s trade liberalisation started in the mid 1980s (see Jebuni et al), the momentum of the liberalisation continued into the 1990s. Ocran, Osei and Adjasi (2006) observed that, exports as a ratio of GDP in 1990 amounted to 17%, which peaked at 28% in 1998 and dropped to 24% by 2000. Imports as a ratio of GDP over the same period also increased from 23% to 43% before slowing down to 35% in 2000. The trade intensity of 25% in 1990 had surged to 93.1% by the end of 2000. However, real wages (based on social security contributions of formal sector employees) show an average 19


decline of about 8% annually over the period 1993 to 1996. Clearly, there appear to be a contrast in the policy outcomes of the trade liberalisation pursued, whilst broad macroeconomic indicators indicate impressive performance some micro indicators such as wage outcomes paints a dismal picture. As a result of this phenomenon, despite the obvious economic performance that the country has chalked over the years the debate is still raging as to the usefulness of trade liberalisation policies as far as welfare of poor households is concerned.

It is instructive to note that even though poverty incidence in Ghana has gone down considerably over the period the direct role of trade liberalisation in poverty alleviation has not received the desired attention in the literature (Ocran, Osei and Adjasi, 2006). Ackah, Morrissey and Appleton (2007) investigate the causal effect of trade policy on household welfare (income) in Ghana during the 1990s and conclude that trade policy reforms in Ghana during the 1990s have resulted in increases in poverty among certain sections of the population, especially the rural unskilled labour households. Unskilled households predominantly employed in Agriculture experience the largest increases in poverty. Higher tariffs are associated with higher incomes for households employed in the sector, implying that some of the economic rents are shared with labour, so that liberalisation could reduce incomes and potentially increase poverty, at least in the short run, but with differing effects across skill groups (Ackah et al, 2007).

The GLSS 3 data analysis on poverty trends indicates that, the income poverty fell from 51.7% of the population in 1991/92 to 39.5% in 1998/99. But there are strong geographic patterns to this, with almost all the poverty reduction having occurred in the urban areas. 20


Elsewhere poverty has fallen little, or even increased, especially when more attention is placed on the depth of poverty (the severity index) or when a lower extreme poverty line is used (Coulombe and McKay, 2004). Aryeetey, 2005 observes that the link between openness to trade, income distribution and poverty in Ghana shows that trade openness deteriorated sharply between the 1960s and 1980s as a result of the very restrictive trade and exchange rate regime pursued during that period, except for a short period (19691972) when the Busia administration pursued some trade liberalisation. As a result the per capita income of Ghanaians (used here as a proxy for poverty) also fell drastically from about US$500 in 1960 to US$340 in 1983. In the wake of reform, openness to trade has risen steeply from an index of 0.11 in 1984 to 0.34 in 1987, 0.33 in 1989, 0.36 in 1992, 0.57 in 1998 and further to 0.78 in 2001. We saw earlier how poverty also increased and then fell between 1992 and 1998. It may be noted that this period also saw improvements as well as a worsening of inequality.

There was significant correlation between trade openness and income distribution since reforms began. In fact between the periods 1987 and 1998/1999 income distribution has become relatively egalitarian (despite the marginal increase) in the midst of a tremendous improvement in trade openness. This is confirmed by the simple correlation coefficient of negative 0.84 between trade openness and the Gini coefficient (Aryeetey, 2005).

2.7

Conclusion The transformation of Ghana's economy undertaken in the 1980s was considered a test case for "structural adjustment" prescriptions advocated by international banking institutions. Faced with growing impoverishment in Africa as well as in much of the so21


called developing world, the World Bank and the International Monetary Fund proposed radical programs to revive troubled economies and to restore their productivity. The government turned to these agencies in 1983 and accepted their recommendations in exchange for assistance packages to ease Ghana's economic and social transformation. Foremost among the changes enacted in Ghana was the disengagement of the government from an active role in the economy and the encouragement of free-market forces to promote the efficient and productive development of local resources. The reformers cut government budgets, privatized state enterprises, devalued the currency, and rebuilt industrial infrastructure by means of assistance programs. As in other countries of Africa in the 1980s, government was identified as the problem, and free-market forces were seen as the solution.

By the 1990s, the effects of structural adjustment in Ghana were beginning to be assessed. According to the World Bank and other western financial institutions, the economy had become much more stable, and production was on a more solid footing than it had been a decade earlier. These institutions in general try to imply that exports went up (from US$1216.8 million in 1992 to US$1410.9 million in 1993), government deficits had been reduced (from Čź144.4 billion in 1992 to Čź97.6 billion in 1993) and inflation was reduced (37% in 1990 to 25% in 1993). However, many Ghanaians questioned whether the structural adjustment benefited all Ghanaians or just a few sectors of the economy. Critics of the World Bank point out that it concentrated on infrastructure such as airports, roads, and other macro-economic projects that did little to improve the lives of the average Ghanaian.

22


Under the sway of free-market forces, production had increased in Ghana's traditionally strong sectors, cocoa and gold, thereby reverting to the pre-independence economic structure; but still, a more broadly based economy had not developed. In addition, substantial loans had been contracted by the government to promote those sectors - at the expense of recurrent budget expenditures such as health and education - without a compensatory increase in government revenues. Ironically, the tax breaks prescribed to encourage these sectors worked against increased government revenues, so that by 1992, tax revenues began to drop (from 3.3% of GDP in 1991 to 2.7% of GDP in 1992 (Ocran et al, 2006)). In addition, jobs were not only cut from the once bloated public sector but were not also expanded in the more successful export sectors. Although the government claimed its finances were much healthier in the 1990s than in the 1980s, the long-term economic and social impact of structural adjustment was uncertain (Library of Congress).

Relying heavily on the exploitation of some non-renewable and even endangered resources, Ghana's economic recovery will have to expand to create a broader and better balanced economy. In addition to cocoa, Ghana's leading export commodities are gold, a non-renewable resource, and timber, the harvesting of which has included more than eighteen endangered species of trees and has led to alarming deforestation. Furthermore, Ghana's ocean waters are seriously overfished, leading the government to ban the catching of shellfish. According to the Ghanaian Government, these resources could be used to develop local manufacturing, like the goal of Nkrumah tried to reach through direct state intervention thirty years ago. Local manufacturing could create jobs, cut the import bill, and provide a more diversified economic base. The question for Ghana is

23


whether free-market forces will be more successful in promoting healthy economic expansion than the failed policies of direct state intervention.

24


CHAPTER THREE THEORETICAL AND EMPIRICAL LITERATURE REVIEW 3.1

Introduction This chapter discusses the theoretical and empirical literature on trade liberalisation and economic growth. The rest of the chapter is organised into three parts as follows: the first part which is section 3.2 discusses the theoretical literature on economic growth and trade liberalisation. The second part which is section 3.3 reviews the empirical literature on relationship and impact of liberalisation on economic growth whist the last part of the chapter which is section 3.4 makes concluding remarks on the literature review.

3.2

The Theoretical Literature

3.2.1

Theories of economic growth There have broadly been three main phases in thinking about the relationship between the trade liberalisation regime of a country and its rate of economic growth: neoclassical, endogenous growth and the institutional approach. In the neoclassical approach, trade patterns among countries are determined by comparative advantage, i.e., where each country maximises its welfare by concentrating on the activities in which it is most economically efficient. The neoclassical approach to the trade-growth nexus invokes general equilibrium models with constant or decreasing returns to scale. Moreover, it is built upon the choices of rational individuals acting solely through markets. Trade patterns among countries are determined by comparative advantage, either in the form of technology differences, as in Ricardian models, or of resource endowments, as in Heckscher-Ohlin models. The neoclassical models of international trade theory in general predict that a country will have static gains from lowering its trade barriers. Perhaps one 25


of the most important static gains from trade liberalisation predicted by neoclassical models is the increase in allocative efficiency. Since trade policy has an important impact on the transmission of international price signals, lowering trade barriers will lead to a reallocation of resources to the sectors with comparative advantage. As a result, resources are used more efficiently and economic growth will occur which will lead to increase in the welfare of the country as a whole. However, the gains from trade liberalisation are static by nature of the neoclassical models and trade policy like other government policies has only level effects, not growth effects, a well-known prediction of neoclassical growth models as in Solow (1956) and Swan (1956).

Endogenous growth approach (also called new growth theory) has proliferated since the mid-1980s and closely shows the dynamic gains of trade liberalization. Much has been made of the endogenous growth theory, however, in many ways it differs only slightly from the neoclassical model. Certain features are common to all growth models. First, they incorporate a produced accumulable factor, which is a durable input whose stock increases over time—physical capital, human capital, or technology. Second, if an increase in the productivity of the inputs producing the accumulable factor occurs at some point, an increase will occur in the rate of accumulation and the growth of output in subsequent periods. A key difference between the neoclassical and endogenous growth models is how long this increased growth lasts.

In neoclassical theory, the increase in the growth rate eventually converges to zero, whereas in the endogenous growth theory the increase can be permanent. The source of this difference is the assumptions about the income share of the accumulable factor. If 26


this share is low, as in the neoclassical model, any increase in, say, capital, in one period does not yield a large increase in production of capital, thus dampening the accumulation process, causing it to converge. If the share is high, as in the endogenous growth models, any increase in capital inputs will yield a larger increase in production of new capital, causing the accumulation process to last longer, possibly indefinitely, in which case permanent growth effects are possible. According to the endogenous growth theory approach, trade policy can impact on income and long-run growth through scale effects, allocation effects, spillover effects and redundancy effects.

Scale effects: A common feature of endogenous growth models is that the size of markets or scale of factor endowments directly affects the long-run growth rate. The integration of markets through trade can create scale effects via the integration of goods markets or flows of intangible and non-rival “knowledge capital�. Examples of dynamic gains from trade via scale effects can be found in the models of Rivera-Batiz and Romer (1991) and Grossman and Helpman (1991). To focus on scale effects, relative prices or technological designs or blue prints are fixed by assuming a Ricardian structure of the economy. Market expansion created by trade raises the profitability of research and development (R&D) and leads to an increase in the growth rate.

Allocation effects: The static gains from the reallocation of resources in neoclassical models can be sustained and transformed into a growth effect if the changes in the composition of national output are related to the production of accumulable factors. If more resources are allocated to the sector producing the accumulable factor, growth will be enhanced. For developing countries, access to cheap imported capital goods is perhaps 27


the most compelling mechanism linking trade and growth. Protectionist policies that restrict the import of capital equipment reduce real investment and lower the rate at which physical capital accumulates. As a result, the rate of long-run growth - as commonly predicted by the endogenous growth theory – is reduced, and if technical progress is embodied in capital goods, the negative impact of protection on growth will be magnified.

Spillover effects: One important consequence of international trade is the diffusion and integration of technological knowledge. Integrating world markets facilitates access to the knowledge available in other nations. Technical progress embodied in goods represents an opportunity for countries engaging in international trade to learn from trading partners.

In the literature investigating the nexus between growth and trade via technological spillovers, the diffusion process is modelled in two main ways. The diffusion can be a non-purposeful activity, and through trade economies are simply provided with access to a world pool of knowledge that is freely available. This approach is taken by, for instance, Feenstra (1996) and Grossman and Helpman (1990, 1991). Another approach is to model the diffusion as a purposeful activity in which the less developed countries can imitate technology available in the more developed countries. Examples of these leaderfollower models of technological progress can be found in Segerstrom et al. (1990), Barro and Sala-i-Martin (1995) and Eaton and Kortum (1996).

28


Redundancy effects: The redundancy effect of trade policy on growth is closely related to the characteristics of knowledge. Since knowledge is a non-rival good, opening the economy can reduce the unnecessary waste of resources devoted to R&D from a global point of view. Increased foreign competition in R&D as a result of trade liberalization can eliminate redundancy in research across countries. Consequently, the global resources devoted to R&D will be used more effectively and the larger global stock of knowledge provides an extra boost to growth. Theoretical models in which the redundancy effect is used can be found in Grossman and Helpman (1991) and Rivera Batiz and Romer (1991). Other papers (e.g. Harrod, 1939) relax this assumption to model technological diffusion between countries explicitly. Technology diffusion may occur through the imitation process, in which the follower country carries out costly imitation of products already developed in the leader country. There could be some hazard to the imitation process if successful innovators seek patents in other (follower) countries, or if there is strong international enforcement of the relevant intellectual property rights.

The third approach is institutions. With the resurgence of institutional economics in the 1990s, economists (and aid donors) have turned their attention to the role of institutional factors in examining the impact of changes in levels of tariffs and quotas on economic performance. In the view of New Institutional Economics (NIE), trade reform is institutional reform and the changes in tariffs and quotas typically constitute only a small part of a much more complex process. Trade liberalisation is associated with changes in the government’s relationship with the private sector and with the rest of the world. Trade liberalisation sets new rules and expectations regarding how these policy choices are made and implemented, and establishes new constraints and opportunities for economic 29


policy. As North (1990) describes them, economic institutions range from taboos, customs, and traditions in what are called traditional societies, to formal, written constitutions and laws governing economic, political and social behaviour in a modern society. North (1990), Olson (1996), and De Soto (2000) stressed the overriding importance for economic growth of property rights and enforcement of contracts. Welldefined and secure property rights and impartial enforcement of contracts between parties are the basis for a market economy. If these conditions do not hold, market activity will be infeasible or highly sub-optimal. In particular, people will be reluctant to invest in fixed assets and engage in long-term contracts.

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. Theoretical growth studies suggest at best a very complex and ambiguous relationship between trade restrictions and growth. The endogenous growth literature has been diverse enough to provide a different array of models in which trade restrictions can decrease or increase the worldwide rate of growth (Yanikkaya, 2003). It should be noted that, if trading partners are asymmetric countries in the sense that they have considerably different technologies and endowments, even if economic integration raises the worldwide growth rate, it may adversely affect individual countries. 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. Even though these two concepts, trade volumes and trade restrictions, are very closely related, their 30


relationship with growth may differ considerably. This is because there are several other very important factors that affect a country’s external sector, such as geographical factors, country size, and income. In other words, one should be as clear as possible about which openness measure he uses and the exact mechanisms through which it affects the growth. Thus, it becomes simple to show relationship between liberalization and economic growth since liberalization is about trade policies.

3.2.2

Theory of trade liberalisation The phenomenal differences among the growth rates of the East Asian, the Latin American, and Sub-Saharan African countries over the last several decades have stimulated a renewed interest in the effects of trade policies on growth. During most of the 20th century, import substitution industrialization (ISI) strategies dominated most developing countries’ development strategies. While developing countries in Latin America that followed ISI strategies experienced relatively lower growth rates, East Asian countries, that employed export-promotion policies, consistently outperformed other countries. This probably explains why a growing body of empirical and theoretical research has shifted towards examining the relationship between trade liberalization and the economic performance of countries since the late 1970s (Yanikkaya, 2003). There can be little doubt that, historically, trade has acted as an important engine of growth for countries at different stages of their developmental processes, not only by contributing to a more efficient allocation of resources within the countries, but also by conveying growth from one part of the world to another. There are static and dynamic gains from trade between countries but there is nothing in the theory of trade that says that the gains are equitably distributed. In the world economy since 1950 there has been a 31


massive liberalisation of world trade, first under the auspices of the General Agreement on Tariffs and Trade (GATT), established in 1947, and now under the auspices of the World Trade Organisation (WTO) which replaced the GATT in 1993. Tariff levels in high-income developed countries have come down dramatically whilst in developing countries, tariff levels have also been reduced, although they still remain relatively high especially in the low-and middle-income countries. Non-tariff barriers to trade, such as quotas, licenses and technical specifications, are also being gradually dismantled, but rather more slowly than tariffs (Thirlwall, 2000).

In the 19th century, Adam Smith’s productivity doctrine of the benefits of trade developed into export driven argument, particularly in the colonies, which explains why classical trade theory is often associated with colonialism. Following Smith, David Ricardo (1772-1823) developed 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 (although not made explicit), countries can reap welfare gains by specialising in the production of those goods with the lowest opportunity cost and trading the surplus of production 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 takes place based on comparative advantage. These are the trade-creation gains that arise within Customs Unions or Free Trade Areas as the barriers to trade are removed between members, but the gains are once-for-all (Thirlwall, 2000). Once the tariff barriers have been removed, and no further reallocation takes place, the static gains 32


are exhausted. This is in contrast to the dynamic gains from trade which 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, particularly through foreign direct investment. It is the dynamic gains from trade that are focused on in modern trade theory (see Helpman and Krugman, 1985) and in “new� growth theory (see Grossman and Helpman, 1991), and which constitute a vital link in the causal chain between exports and growth.

Given the predictions of trade theory and the facts, it is important to point out that the issue for developing countries in general, and Africa in particular, is not so much whether to trade but in what to trade, and the terms on which trade should take place with the developed countries of the world (or between themselves). It is not doubtful that there are both static and dynamic gains from trade and that trade provides a vent for surplus production. However, the argument is whether the overall gains to developing countries could be greater if the pattern of trade was different from its present structure and if the developed countries modified their policies towards the developing world. For instance, it is still the case that over 60% of export earnings of developing countries (and over 80 percent in Africa) are derived from the sale of primary commodities, and the price of primary commodities relative to manufactures has been deteriorating for at least a century at an average rate of approximately 0.5 percent per annum (Thirlwall, 1995). Also, while the developed world argues free trade for developing countries, it continues to protect its own markets from imports from developing countries, particularly agricultural produce and textiles. 33


Also, major exports of developing countries are mainly primary commodities which are land-based activities and subject to diminishing returns. There is a limit to employment in diminishing returns activities set by the point where the marginal product of labour falls to the minimum subsistence wage. No such problem arises in manufacturing, such as cloth production, where no fixed factors of production are involved, and production may be subject to increasing returns. The preservation of full employment in both activities, as resource reallocation takes place, implicitly assumes non-diminishing returns in both activities; that is, constant or decreasing costs (Bhagwati, 1958). In addition, primary commodities have both a low price and income elasticity of demand which means that when supply increases, prices can drop dramatically, and demand will grow only slowly with income growth.

3.3

Empirical literature Several studies have focused on theoretical positive impact of trade liberalisation on economic growth based on comparative advantage. But many empirical studies have thrown up some evidence to show that trade liberalisation positively affects economic growth under certain conditions. For instance, Yanikkaya (2003) estimated the effect of trade liberalization on per capita income growth for 120 countries for the period 1970 to 1997. He used two types of trade openness measures. The first openness measure was estimated by using trade volumes which include different ratios of trade variables (exports, imports, exports plus imports and trade with developed countries) with GDP. Another measure based on trade restrictiveness estimated by calculating restrictions on foreign exchange on bilateral payments and current transactions. The results of the 34


Generalize Method of Movement (GMM) estimates showed that first group of openness, based on trade volumes were significant and positively related with per capita growth. However, for developing countries, openness based on trade restrictions was also significant and positively related with per capita growth. He therefore concluded that trade restrictions in developing countries may cause faster GDP growth.

Edward (1992) used a cross country data set to analyse the relations between trade openness (trade intervention and distortions) and GDP growth of 30 developing countries over the period 1970 to 1982. In Edward (1992) model, two basic sets of trade policy indicators were used. The first set refers to openness and measures of trade policy (tariff and Non- Tariff Barriers – (NTB)) which restrict imports. The second set measures trade intervention and captured the extent to which trade policy distorted trade. The results of the model, estimated by OLS, showed that all the four openness indicators were positively related with real per capita GDP growth, while trade intervention indexes were found to be significant and negatively associated with GDP growth. These studies support the hypothesis that countries with a more open trade regime have tended to grow faster, and a more distorted trade regime will tend to grow slower.

Also, Edwards (1998) used comparative data for 93 countries to analyse the robustness of the relationship between openness and total factor productivity (TFP) growth. He used nine indexes of trade policy to analyse the connection between trade policy and TFP growth for the period1980 to 1990. Among these nine indexes, three were related to openness, a higher value of which denotes a lower degree of policy intervention in international trade. The other six were related to trade distortions, for which higher values 35


denote a greater departure from free trade. The results of OLS estimates found trade openness indexes significant with positive signs and trade distortion indexes were significant with negative signs. This relationship suggests that more open countries will tend to experience faster productivity growth than more protectionist countries. An interesting point of the study was that the coefficients were very small, up to 100

th

2

decimals points, while the value of R was also very low.

Wacziarg (2001) investigated the links between trade policy and GDP growth in a panel of 57 countries for the period of 1970 to 1989. His study employs a fully specified empirical model to evaluate the six channels though which trade policy might affect growth. He measured trade openness through an index which consisted of three trade policy variables, Tariff barrier, captured by share of import duties to total imports, Nontariff barriers, captured by un-weighted coverage ratio for the pre-Uruguay Round time period and a dummy variable (liberalization status). The fixed estimate OLS results showed that three channel variables i.e., FDI inflows as share of GDP, domestic investment rate and macroeconomic policy, were significant. He therefore concluded that there is a positive relationship between trade openness and GDP growth.

Siddiqui and Iqbal (2005) estimated the impact of trade liberalization on output growth for Pakistan which is based on the model by Sinha and Sinha (2000). The volume of trade (import plus export) was used as proxy of openness and for that matter the degree of liberalization. The estimated co-integration equations for the model showed that there is long-run negative relationship between trade growth and GDP growth. However, when they separated the total trade volume into export and import, they found insignificant 36


positive relationship between GDP growth and export and import. The Granger Causality tests also showed insignificant relationship between trade growth and GDP growth.

Furthermore, Santos-Paulino (2002) examined the impact of trade liberalization on export growth for a sample of 22 developing economies between 1972 and 1998. Santos-Paulino (2002) used a typical export growth function which postulates that exports volume depends upon real exchange rate and world income. Trade openness is measured in two ways where, firstly the ratio of export duties to total export, as indicator of the degree of anti-export bias is used and secondly a dummy variable of timing of the introduction of trade liberalization measures. The results of OLS estimate showed export duty significant with a negative sign and the dummy variable is also significant with a positive sign. Therefore it was concluded that exports grow faster in open economies.

Ahmed, Y. and Anoruo, E. (2000) investigated long run relationship between GDP growth and openness for five South East Asian countries - Philippines, Indonesia, Malaysia, Singapore and Thailand - for the period 1960 to 1997. Export plus import growth rate is used as proxy of openness. The Johansen estimation results rejected the hypothesis that there is no cointegration between economic growth (GDP) and trade openness while the hypothesis that error correction term is significant could not be rejected. This Vector Error Correction estimates showed bi-direction causality between economic growth and trade openness.

37


3.4

Concluding remark on the literature Trade liberalisation seems to benefit developing economies such as Ghana as it comes with inflows of foreign direct investment, remittances and foreign aid. Even, following the trade theories of Ricardo and Heckscher-Ohlin, one can early say that when the economy of Ghana is liberalisation it would bring more opportunity as goods and services that could not be produced in Ghana can be acquired with ease internationally. However, the theories portray the positive link between liberalisation and economic growth as if there is no cost and other implication for a small economy like Ghana. For instance, when Ghana and its trading partners are assumed asymmetric countries in terms different technologies and endowments, even if economic integration raises their economic growth rate, it is still likely to adversely affect individual countries. In general, one can conclude therefore that, there is enough evidence from both theoretical and empirical literature to support the fact that trade openness or liberalisation can cause economic growth to happen. Also, it is sufficient to believe that that countries with a more open trade regime have tended to grow faster, and a more distorted trade regime will tend to grow slower. This is supported by studies conducted by Siddiqui and Iqbal (2005) on the impact of trade liberalization on output growth in Pakistanis economy, Santos-Paulino (2002) on the impact of trade liberalization on export growth for some 22 developing economies, and Ahmed, Y. and Anoruo, E. (2000) who investigated long run relationship between GDP growth and openness for five South East Asian countries.

38


CHAPTER FOUR METHODOLOGY AND DISCUSSION OF FINDINGS 4.1

Introduction This chapter deals with the method of analysis and theoretical framework of model specifications, description of properties of the data and model. It also contains trend of economic growth and trade openness in Ghana from 1984 to 2011, and the presentation and analysis of the regression outputs.

4.2

Method of Analysis and Theoretical Framework for the model specification

4.2.1

Method of Analysis The method used was mainly regression analysis involving standard ordinary least square (OLS) techniques to estimate the parametric coefficients of the explanatory variables in the econometric model based on the theoretical and empirical insights. In order to know if a VECM is appropriate and to incorporate recent developments in time series modelling, the study looked beyond the traditional regression problems of autocorrelation, multicollinearity and simultaneity and considered the dynamic specification of the series and a cointegration test has to be conducted. Augmented Dickey-Fuller (ADF) and Phillip-Perron (PP) tests were used to establish stationarity to ensure that results are appropriate for policy recommendations (Charemza and Deadman, 1992). Following Johansen (1988), researchers use ADF and PP method of differencing to deduce the order of cointegration of their time series data. Again, on the advice of Engel and Granger (1987) on differencing, researchers reparameterised their model into an Error Correction Model (ECM) to capture possible long run information that might have been lost in the course of differencing. 39


E-view software version and MS excel are utilized for estimating purposes and to aid analysis of the results using the data. These are used to estimate parameters of the model chosen, alongside with other methods of analysis such as mean, standard error, unit root and cointegration, and Granger causality test to provide numerical coefficient for each explanatory variables that are suitable for both relationship and impact analysis. However, emphasis is placed on the correlation between economic growth and trade liberalisation. This helps facilitate economic policy analysis and recommendations on the trade liberalisation.

4.2.2

Theoretical Framework This sub-section provides the theoretical framework for the model. It is predominantly based on the model by Sinha and Sinha (2000). The functional form is specified as: GDP Growth = f (Trade growth, Investment growth, Population growth) This was linearised to the basic regression which takes the form:

Where the dependable variable GDP GROWTH is the economic growth represented by real GDP, TRADE GROWTH is sum of imports and exports as a contribution of GDP, INVESTMENT GROWTH is the change in capital stock, POPULATION GROWTH is the rate of growth of population and

is error term.

40


4.2.3

Model Specification The Keynesian macroeconomic thought has identified various factors that influence the growth of a country which include exchange rate, trade openness, interest rate, inflation, government budget deficits, imports, exports, money supply and foreign direct investment. The model specification is a modification and extension of the models estimated at the aggregated macroeconomic level by Sinha and Sinha (2000) and Siddiqui and Iqbal (2005). The model by Sinha and Sinha (2000) and Siddiqui and Iqbal (2005) are both specified as growth rate of GDP is a function of the trade growth, investment growth and population growth. This study is modified and extended by including trade openness, real exchange rate, inflation and FDI in percentage of GDP. The modified model is aimed at examining the impact of the openness of the economy (i.e. trade liberalisation), real exchange rate, inflation rate, and foreign direct investment as a percentage of GDP on economic growth. Thus, the functional relationship is given as: ECONOMIC GROWTH = f (TRADE LIBERALISATION, EXCHANGE RATE, INFLATION RATE and FDI)

The modified model adopted from Sinha and Sinha (2000) for the purpose of this study is specified as: GDPGt = β0 + β1OPEN t + β2REXC t + β3INFLt +β4 FDIGDPt + µt Where, GDPGt is a measure of economic growth and OPENt is a measure of openness of the economy (i.e. trade liberalisation) REXCt is the real exchange rate, INFLt is the inflation rate, FDIGDPt is foreign direct investment as a percentage of GDP, and µ t is the random error term capturing all other factors which influence economic growth but not captured in the model. 41


The error correction model (ECM) provides the means of reconciling the short-run behaviour of an economic variable with its long-run behaviour. For the purpose of the specified model, the ECM is specified as follows:

Where the , β1 , β 2, β3, and β4 are representing the short-run coefficients of the model’s convergence to equilibrium and ECMt-1 is the Error Correction Model. The coefficient of Error Correction Model (p) measures the speed of adjustment to obtain equilibrium in the event of shocks to the system. The parameter β 1 is the most important parameter in this study because it measures the impact of trade liberalisation on economic growth. In other words, it measures the change in economic growth as a result of a unit change in the value of trade openness, all things being equal. In this study, GDP growth in real Gross Domestic Product is used to measure economic growth i.e. GDPG = (GDPt - GDPt-1)/ GDPt-1 whiles Openness (i.e. trade liberalisation) of the economy is also measured as (Exports + imports)/ GDP. Exports in this case capture exports in goods and services. Reported annual inflation rate is used in the model to measure inflation.

4.3

Description of Variables of the Model and Data Source 

GDP growth: There are many ways of measuring economic growth in a country. These include growth in real per capita Gross Domestic Product and growth in real Gross Domestic Product. This study uses growth in Gross Domestic Product to measure economic growth. Data on GDP was sourced from the Ghana Statistical Service to aid the regression analysis to achieve the objective of the study. Economic growth is the dependant variable in the model specification which is said to be 42


explained by the independent variables: real exchange rate, inflation rate, share of FDI in GDP, trade liberalisation.



Trade Liberalisation/Openness: Trade liberalisation is included in the model as an explanatory variable to capture the impact of trade openness on economic growth. Trade liberalization as argued leads to a change in the relative prices of traded and non traded goods. It is believed that the change in relative prices will induce changes in the allocation of resources to different activities and hence changes in both subsectoral and aggregate levels of production. These changes have the potential both to reduce poverty and increase income levels. Thus, trade liberalization enhances economic growth. There are many proxies that can be used to measure trade liberalization; however this study uses openness as a measure of trade liberalization. This measure has been chosen over other measures because it has been found that this measure captures almost every aspect of trade liberalization (Sinha and Sinha, 2000; Siddiqui and Igbal, 2005). In addition, it is assumed that trade liberalisation has a positive relationship with economic growth and thus the a priori expectation is positive.



Real exchange rate: the real exchange rate is one of the important explanatory variables in the model specified to examine the impact analysis of economic growth. The real exchange rate affects economic growth of a country in the sense that it affects the amount of goods and services that are imported and exported in a country. On the part of imports, the depreciation of the domestic currency leads to a reduction in imports while on the part of exports depreciation of the domestic currency leads to 43


increase in exports with the assumption that Marshal-Lerner Condition holds. The net effect of the depreciation of the domestic currency is therefore an increase in net exports. This enhances national output in the country hence economic growth. For this reason, the a priori expectation of the real exchange rate as an explanatory variable is positive. That is, it is expected that there would be positive relationship between economic growth and real exchange rate in the model.



Inflation: Inflation rate is one of the explanatory variables of the model. Inflation is an economic canker that every country will like to eliminate, even though, a level of inflation is needed to raise employment level. This is due to the negative consequences that it has on economic growth in an economy. High inflation leads to high cost of business, uncertainty, political instability etc. These are inimical to economic growth. It is for this reason that inflation is included in the model. Thus, it is assumed to have a negative relationship with economic growth and therefore, the a priori expectation is a negative sign.



Foreign Direct Investment: FDI is one of the variables considered by the model as it has impact on economic growth. Theory provides conflicting predictions concerning the growth effects of foreign direct investment. Foreign direct investment may boost the productivity of all firms (i.e. including those not receiving the capital). Thus transfers of technology through foreign direct investment may have substantial spillover effects for the entire economy which in turn leads to economic growth. Foreign direct investment is included in the model so as to ascertain its growth impact

44


in Ghana. The a priori expectation sign for FDI is positive in that it is expected to lead to increase in economic growth.



Other Factors: The other factors not included in the model and errors are captured by the error term.

4.4

Trend of Trade Liberalisation and Economic Growth The economic growth rate and trade openness from 1984 to 2011 are presented in Figure 1. It can be deduced that, the economy suffered in the mid 1980s. During these periods, the economy of Ghana experienced remarkable growth rates especially, starting from the beginning of liberalisation in 1984, a growth rate of 2.6% was record after series of negative growth rates. The economy became relatively stable from 1985 and continued with positive real GDP rates up to 2011. The average GDP growth rate during the 28-year period was 5.3% and a standard deviation of 2.4% with the highest GDP growth rate of 16.2% occurring in 2011 and the lowest GDP growth rate of 2.6% occurring in 1984. In 1988, the economy experienced growth rate of 6.2% which increased at a decreasing rate of 3.3% in 1990. The GDP growth increased from 3.8% in 1994 to 16.2% in 2011.

45


Figure 1: Trends of GDP Growth and Trade Openness 1984 - 2011

120.00

GDP growth

Trade Openness 100.00

60.00

40.00

20.00

It can also be deduced from Figure 1 that, the more the trade is liberalised the higher the GDP growth rate and for that matter economic growth. For instance, in 1984 when trade regime was liberalised by 10.3%, real GDP growth was 2.6% and real GDP growth was enhanced with trade regime. As trade regime declined the real GDP growth declined in 1989 and 1990. However, 1993 had seen a green light as real GDP growth increase by 4.97% from 3.9% in 1992 when trade regime increased by 43.9% from 40.3% of GDP in 1992. In 2006, trade regime became 51.6% of GDP leading to a real GDP growth of 6.4% and when trade regime intensified in 2008 to 69.8% of GDP, real GDP growth intensified leading to economic growth rate of 7.2%.

46

2011;

2010;

2009;

2008;

2007;

2006;

2005;

2004;

2003;

2002;

Years 1984 - 2011

2001;

2000;

1999;

1998;

1997;

1996;

1995;

1994;

1993;

1992;

1991;

1990;

1989;

1988;

1987;

1986;

1985;

0.00 1984;

Percentage

80.00


An anomaly can be observed in 2009 and 2010. The trade regime increased from 69.8% to 73.1% in 2009 but GDP growth declined from 7.2% to 4.7% in the same year. In 2010, trade regime declined to 53.8% whilst GDP growth increased to 5.7%.

4.5

The Time Series Properties of the Variables This section considers brief discussion on time series characteristics such as the unit root test consisting of Augmented Deckey-Fuller test and Phillips-Parron test; cointegration test and; vector error correction model. These are presented in the following sub-sections.

4.5.1

Unit root test For the purpose of this study, unit root tests of augmented Dickey-Fuller (ADF) and Phillip-Perron (PP) were used in order to avoid spurious results. These tests of ADF (Dickey and Fuller, 1979) and PP (Phillips-Perron, 1988) were performed at both level and difference to determine the time-series properties of the data employed in the analysis. The results of the ADF and PP unit root tests at level and difference are presented in Tables as follows: Table 4.1 shows ADF test at level, Table 4.2 shows ADF test at difference whilst the results of the PP tests at level and difference are presented in Table 4.3 and Table 4.4 respectively. Table 4.1: Result of ADF Unit Root Test of variables at their levels Variable

t-statistic

1% Critical Value* 5% Critical Value 10% Critical Value

GDPG

-0.38746

-3.7076

-2.9798

-2.6290

OPEN

-3.5527

-3.7076

-2.9798***

-2.6290***

REXC

3.149505

-3.7076

-2.9798***

-2.6290***

47


INFL

-2.43328

-3.7076

-2.9798

-2.6290

FDIGDP

3.628784

-3.7076

-2.9798***

-2.6290***

*MacKinnon critical values for rejection of hypothesis of a unit root. *** Means significant.

Table 4.2: Result of ADF Unit Root Test of variables at their difference Variable

t-statistic

ΔGDPG

-3.616

ΔOPEN

1% Critical Value* 5% Critical Value 10% Critical Value -3.7204

-2.9850***

-2.6318***

-5.91913

-3.7204***

-2.9850***

-2.6318***

ΔREXC

-2.20202

-3.7204

ΔINFL

-4.67007

ΔFDIGDP

0.531496

-3.7204*** -3.7204

-2.9850 -2.9850*** -2.9850

-2.6318 -2.6318*** -2.6318

*MacKinnon critical values for rejection of hypothesis of a unit root. *** Means significant.

Table 4.3: Results of Philip-Perron Unit Root Test of variables at their levels Variable

t-statistic

1% Critical Value* 5% Critical Value 10% Critical Value

GDPG

-1.02392

-3.6959

-2.9750

-2.6265

OPEN

-3.32358

-3.6959

-2.9750***

-2.6265***

REXC

3.098539

-3.6959

-2.9750***

-2.6265***

INFL

-3.11428

-3.6959

-2.9750***

-2.6265***

FDIGDP

4.522682

-3.6959***

-2.9750***

-2.6265***

*MacKinnon critical values for rejection of hypothesis of a unit root. *** Means significant.

48


Table 4.4: Results of Philip-Perron Unit Root Test of variables at their difference Variable

t-statistic 1% Critical Value*

5% Critical Value

ΔGDPG

-2.52164

-3.7076

ΔOPEN

-6.32478

-3.7076***

-2.9798***

-2.6290***

ΔREXC

-6.52108

-3.7076***

-2.9798***

-2.6290***

ΔINFL

-6.82656

-3.7076***

-2.9798***

-2.6290***

ΔFDIGDP

-2.1286

-3.7076

-2.9798

-2.9798

10% Critical Value -2.6290

-2.6290

*MacKinnon critical values for rejection of hypothesis of a unit root. *** Means significant.

Just as in the literature, the ADF and Phillip-Perron tests have a null of unit root against the alternative of trend stationary (Dickey and Fuller, 1979; Phillips-Perron, 1988). The more negative the test statistic the stronger the rejection of the hypothesis that there is a unit root at 1%, 5% or 10% level of significance. In other words, for the Null hypothesis to be rejected, the test statistics must be greater than the critical values in absolute terms.

The unit root test for ADF at level in Table 4.1 indicates that all the variables are nonstationary under critical value at 1% level of significance since their test statistics are less negative than the critical value. That is in absolute terms the variables have test statistics less than the critical value at 1%. GDPG and INFL are not significant at 1%, 5% and 10% levels of significance because their absolute values are less than the critical value at 1%, 5% and 10%. However, OPEN, REXC and FDIGDP are significant at 5% and 10% levels of significance (see Table 4.1).

49


The unit root test for ADF at first difference in Table 4.2 shows that GDPG is not significant at 1% critical value. GDPG, OPEN and INFL are statistically significant at 5% and 10% levels of significance since they are rejected because their test statistics are more negative than the critical values at 5% and 10%. OPEN and INFL are both significant at 1% critical values. However, REXC and FDIGDP are not statistically significant at 1%, 5% and 10% levels of significance (see Table 4.2).

The unit root test for PP of variables at their levels as presented in Table 4.3 indicates all the variables with the exception of FDIGDP are insignificant at 1% critical values. GDPG is not significant at 5% and 10% levels of significance, OPEN, REXC and INFL are significant at 5% and 10% levels of significance because in absolute terms their tstatistics are greater than their critical values at 5% and 10% leading to the rejection of the null hypothesis (see Table 4.3). The unit root test for PP of variables at their first difference shown in Table 4.4 indicates all the variables except GDPG and FDIGDP are statistically significant at 1%, 5% and 10% levels of significance. Given that both the Augmented Dickey Fuller and Phillip -Perron tests are superior at their first differences, the study can go ahead to rely on the test results as the basis for investigating cointegration relationship between the variables (see Table 4.4).

4.5.2

Co-integration test The regression equation has shown a relationship between the economic growth and the factors such as trade liberalisation, real exchange rate, inflation rate and FDI contribution to GDP. However, the tests of such a regression equation may suggest a statistically significant relationship between some of these variables where there is a possibility that none, in actual fact, exists. Thus, co-integration test is conducted here to help find or to 50


determine whether a group of non – stationary series is co-integrated or not. That is, a cointegration test is conducted on the series of all the variables and observed values of the t-statistics of the coefficient estimates calculated under the assumption that the true value of the coefficient equals zero as suggested by Granger and Newbold (1974) to determine whether a true (long-run) relationship exists between the variables. Table 4.5 presents the results of the Johansen cointegration test.

Table 4.5: Results of Johansen co-integration test Eigenvalue Likelihood Ratio 5% Critical Value 1% Critical Value Hypothesized No. of CE(s) 0.737678

83.86484

68.52

76.07

None **

0.65619

49.07208

47.21

54.46

At most 1 *

0.39787

21.31275

29.68

35.65

At most 2

0.266337

8.123408

15.41

20.04

At most 3

0.00273

0.071066

3.76

6.65

At most 4

*(**) denotes rejection of the hypothesis at 5% (1%) significance level. L.R. test indicates 2 cointegrating equation(s) at 5% significance level

As noted earlier, the study investigates the possible co-integrating relationships between variables in economic growth function that was specified. For instance, two or more variables are said to be co-integrated, i.e., they exhibit long-run equilibrium relationships, if they share common trends. The co-integration among variables rules out the possibility of the estimated relationships being “spurious”. Spurious estimates lead to meaningless outcomes and thus lead to wrong conclusions. In this study the Johansen test procedure is adopted for testing for co-integration relationship between economic growth and key 51


determinants such as the trade liberalisation, real exchange rate, inflation rate, and ratio of FDI to GDP. To accept the null hypothesis, the calculated test statistics must be smaller than their associated critical values.

Based on the Eigenvalue and Likelihood Ratio and their corresponding critical values, the null hypothesis of no co-integration between the economic growth and key determinants of interest are rejected at 5% level of significance, while the hypothesis that there is at most (2) co-integrating equation was rejected at the 5% significance level. The results confirm the existence of an underlying long-run stationary steady-state relationship between the economic growth and the explanatory variables since a linear combination of two or more non-stationary series are co-integrated. Given that there is at least one cointegrating vector in the model, the equation can be estimated in levels. The variables of the model appear to share a long-run equilibrium relationship. So that, over long period of time the variables will not move independently of each other but will rather be linked in the long-run.

4.6

Analysis of findings of the regression results

4.6.1

Long Run Growth Relationship of Cointegration Equation The result of the regression result presented in Table 4.6 shows the long run relationship between dependent variable, economic growth (GDPG) and the explanatory variables, that is, Openness to trade or trade liberalisation (OPEN), real exchange rate (REXC), annual inflation rate (INFL) and FDI contribution to GDP (FDIGDP). The result of the cointegration regression for long run coefficients shows that, the null hypothesis of all the key determinants of economic growth or explanatory variables except REXC are rejected 52


at 5% level of significance since their t-statistics are greater than the t-critical value, implying that they are statistically significant. REXC is statistically significant only at 10% level of significance because at that probability level the null hypothesis is rejected since the t-statistic is greater than t-critical value. Table 4.6: Results of the long-run Coefficients of Cointegration Equation Variable

Parameter

Coefficient

Stand. Err.

t-Statistic

GDPG(-1)

-

1.00000

-

-

OPEN(-1)

β1

1.46258

0.7595

1.92572**

REXC(-1)

β2

46.3903

6.68828

6.93605**

INFL(-1)

β3

0.10929

0.02213

4.93867**

FDIGDP(-1)

β4

-57.03008

12.4419

-4.58372**

Constant

β0

-1.33073

-

-

*(**) denotes rejection of the hypothesis at 10% (5%) significance level. Critical t-value at 10% (5%) is 1.321 (1.717)

In the long run, the effects of the explanatory variables based on their coefficient estimates on economic growth are that, a percentage increase in the trade liberalisation or openness increases economic growth by about 1.5%. The a priori expectation sign has been proven by the co-integration results as being positive but the coefficient of openness (trade liberalisation) expressed as a ratio of sum of import and export to GDP is found to be significant at 5% significance level. Trade liberalization in the long run can be the engines that would foster the needed technological progress and makes it possible for Ghana to access intermediate inputs and technology transfer from more advanced countries, promotes exports through export led growth and thus generates positive spillovers through exploiting scale economies, and encourages competitiveness and 53


efficiency in both domestic and international markets. This has been consistent with the study conducted by Sakyi (2010) and Balassa (1978). The economy’s experience with liberalisation programme since 1984 had not been promising because growth of exports of manufactures was slow, or moderate, and the structure of GDP has not changed in favour of the manufacturing sector. More importantly, the country faced deindustrialization and thus became vulnerable to liberalization as confirmed in UNCTAD 2005 discussion paper.

Real exchange rate enhances terms of trade, make domestic products competitive in international trade and hence economic growth. The results confirm the a priori positive expectation as predicted by the theory and the long run effect is that, a one percent increase in the real exchange rate would cause economic growth to go up by about 46.4%.

Inflation has a positive coefficient of 0.10929 and has significant impact on GDP growth since it is statistically significant at 5% levels of significance. The results of long run cointegration indicate that a percentage increase in the annual rate of inflation would lead to 0.11% rise in economic growth. It is expected that a rise in inflation raises the cost of borrowing which lowers the rate of capital investment and thus reduces output growth. However, the results obtained here indicate the opposite but other studies have found results similar to what has been obtained here. For instance, Khan and Senhadji (2001) have argued that inflation per se is not harmful to growth. Their study suggested that there is a threshold beyond which inflation is harmful to growth (i.e. inflation negatively affects economic growth). Moreover, it can be stated that when inflation is creeping it is 54


not harmful to growth. The positive relationship between inflation and GDP growth obtained in this study is consistent with the structuralist believe that inflation is essential for economic growth. It is also consistent with the findings of Girijasankar and Chowdhury (2001) who also found a similar long run positive relationship between inflation and GDP growth in four Asian countries namely, Bangladesh, India, Pakistan and Sri Lanka.

The coefficient of FDI as contribution to GDP in the long run growth equation is expected to be positive as predicted by the theory or the a priori expectation. However, this study found the sign to be negative. For instance, a one percentage increase in contribution of FDI to GDP would decrease economic growth by about 57% in the long run because most of the multinationals and foreign firms do not invest their huge profits back into the country but are rather expatriated.

The long run relationship between economic growth and openness to trade is favourable to Ghana according to the co-integration results of the equation. This implies that, in the long run when trade is more liberalised, it contributes to productive activities because some input and machineries are imported to expand employment which in turn adds to GDP and thus will increase economic growth through increase in real GDP. However, trade openness can cause damage or serious injury to domestic manufacturers if other trading partners engage in unfair trade practices such as dumping and subsidies.

55


4.6.2

Short run Growth and Error Correction Model (ECM) This section discusses the short run growth relationship between the economic growth and the key determinants listed in this study. Table 4.7 shows the error correction model which is obtained through estimates of the conditional VECM using ordinary least square in order to test for the presence of short run relationship among the variables. This is achieved through an F-test for the joint significance of the coefficients of lagged levels of the variables. Consequently, each of the variables in the model is taken as a dependent variable and a regression is run on the others. For example, economic growth (D(GDPG(1))) is taken as the dependent variable and regressed on the other key determinant variables. The results indicate there is the existence of cointegration among the variables in the economic growth equation. Table 4.7: Results of Error Correction Model (ECM) Variable

Parameter

Coefficient

Stand. Error

t-statistic

ECM

-0.51033

0.44103

-1.15715*

D(GDPG(-1))

0.15291

0.31742

0.48173

D(OPEN(-1))

β1

0.47425

1.35815

0.34919

D(REXC(-1))

β2

81.80389

24.0049

3.4078**

D(INFL(-1))

β3

0.02621

0.03971

0.65998

D(FDIGDP(-1))

β4

-13.52173

41.8173

-0.32335

Constant

α

0.08616

0.38343

0.22471

R-squared

0.563479

Log likelihood

-47.6032

Adj. R-squared

0.42563

Akaike AIC

4.200242

Schwarz SC

4.538961

Sum Sq. Residuals 59.26389

56


S.E. equation

1.766112

Mean dependent

0.426923

F-statistic

4.087663

S.D. dependent

2.330358

*(**) denotes rejection of the hypothesis at 25% (10%) significance level. Critical t-value at 25% (10%) is 0.686 (1.321)

The results of the ECM shows short-run dynamic economic growth equation selected from the column marked D(GDPG(-1)) in the vector error correction model (VECM). This usually reconciles the short run behaviour of economic growth and its determinants with their long-run behaviour. The existence of co-integration relationships among the variables means that, the estimated Error Correction Model determines the dynamic behaviour of the economic growth equation. The Error Correction Model captures the short run dynamics of the system and its coefficient of negative 0.51033 measures the speed of adjustment to obtain equilibrium in the event of shocks in the economic system. There is a relationship between the variables, that is, any short run disequilibrium in the relationship will revert to equilibrium in the long-run. The result also suggests in the short run, changes in key determinants of growth have significant impact on economic growth.

The coefficients of variables of the ECM equation show that, in the short-run the ECM and real exchange rate (REXC) are statistically significant. However, Trade openness (OPEN), inflation rate (INFL), ratio of FDI to GDP (FDIGDP) and the constant term are statistically insignificant. This implies that in the short run, trade openness, inflation rate and ratio of FDI to GDP are statistically not different from zero and therefore do not influence economic growth. In general, the coefficient of determination, or the R-squared

57


value of 0.563479 is statistically significant at 5% level of significance as indicated by the F-statistic of 4.087663 suggesting joint significance of the determinants in the short run co-integration equation. From indications, about 56.35% of the changes occurring in the economic growth in the short run is explained by changes in the key determinants of trade openness, real exchange rate, inflation rate and foreign direct investment used in the regression equation. The short run expectation signs of trade openness, real exchange rate and inflation are positive whilst FDI is negative as in the long run normalised equation.

Table 4.7 shows that, in the short run a unit increase in trade openness/liberalisation would lead to insignificant increase of about 0.47% in GDP growth as a measure of economic growth. A percentage increase in real exchange rate would cause economic growth to rise by 81.80%. This supports the fact that, devaluation of Ghana’s currency is making exportable products cheaper in the sights of foreigners so that more of domestic products can be bought by them. In the short run, when inflation rate increases by one percent, economic growth would increase by 0.026%. This implies that some level of increased inflation is required to increase employment which would lead to increased GDP and hence economic growth as postulated by the Phillips curve. That is an amount of inflation is required for growth both in the long run and in the short run since a rise in inflation raises GDP growth. A percentage increase in the ratio of FDI to GDP would cause economic growth to decline by 13.52%. In the short run, contribution of FDI to GDP is predicted by theory to enhance economic growth due to the fact that FDI flowed from developed countries to Ghana through multinationals to create multiple effects.

58


4.7

Causality test between Trade Openness and Economic Growth The Table 4.8 presents the correlation matrix of the variables. The correlation coefficients help measure the degree or strength of the linear relationship among variables.

Trade

openness, real exchange rate and foreign direct investment have positive correlation with economic growth whilst there is a negative correlation between inflation rate and economic growth. However, the correlation between economic growth and foreign direct investment is very strong as indicated by a coefficient of 0.8689 whilst there is relatively weak correlation between economic growth and trade openness shown by a coefficient of 0.1613. The correlation between economic growth and real exchange rate has shown a coefficient of 0.6542 indicating a relatively high relationship whilst coefficient of correlation between economic growth and inflation rate is negative 0.3468 which is relatively moderate relationship.

Table 4.8: Correlation Matrix of the Variables GDPG

OPEN

REXC

INFL

FDIGDP

GDPG

1

0.16132

0.654181

-0.34686

0.868885

OPEN

0.16132

1

0.384189

-0.27306

0.274444

REXC

0.654181

0.384189

1

-0.61169

0.764074

INFL

-0.34686

-0.27306

-0.61169

1

-0.34686

FDIGDP

0.868885

0.274444

0.764074

-0.34686

1

Conversely, the correlation between economic growth and the other variables do not necessarily mean causality. The mere fact that economic growth increases (decreases) 59


and others variables increase (decrease) does not imply the increase (decrease) in economic growth is caused by the change in the variables. Therefore, it is necessary that Granger causality is introduced to find out the causal relationship between variables. Table 4.9 presents the results of pairwise Granger causality test and indicates that the null hypothesis that trade openness does not Granger cause economic growth is rejected because the F-statistic value of 0.55097 is greater than the F-critical value of 0.16900. Thus, there is causality between trade liberalisation and economic growth.

The results show that there is causality between real exchange rate and economic growth - that real exchange rate have influence on economic growth. Inflation does not granger cause economic growth as expected because there should be negative relationship whilst FDI Granger causes economic growth. Real exchange rate has a causal relationship with trade openness as indicated by the fact that F-statistic is greater than F-critical. This implies that, real exchange rate influences trade liberalisation. Similarly, inflation, real exchange rate and FDI Granger cause trade liberalisation and thus imply they have influence on trade liberalisation. Table 4.9: Results of Pairwise Granger Causality Tests Null Hypothesis: OPEN does not Granger Cause GDPG GDPG does not Granger Cause OPEN

Obs 26

F-Statistic 0.55097 0.16900

Probability 0.58450* 0.84565

REXC does not Granger Cause GDPG GDPG does not Granger Cause REXC

26

16.1924 1.16355

0.000056* 0.33172

INFL does not Granger Cause GDPG GDPG does not Granger Cause INFL

26

0.67172 0.81370

0.52147 0.45671

FDIGDP does not Granger Cause GDPG GDPG does not Granger Cause FDIGDP

26

6.19985 1.05671

0.00766* 0.36537

REXC does not Granger Cause OPEN OPEN does not Granger Cause REXC

26

2.08280 0.12020

0.14956* 0.88735

INFL does not Granger Cause OPEN

26

1.78535

0.19227*

60


OPEN does not Granger Cause INFL FDIGDP does not Granger Cause OPEN OPEN does not Granger Cause FDIGDP

26

*Granger Causality

61

0.47567

0.62800

2.30782 0.23054

0.12416* 0.79609


CHAPTER FIVE SUMMARYAND CONCLUSION AND POLICY RECOMMENDATIONS 5.1

Summary and Conclusion This study examines the impact of trade openness on economic growth. Trade openness is based on the density of international trade to GDP. This is achieved by summing up imports and exports of a period and dividing it by the GDP of that period. Many studies have been conducted to show that free trade is better than no trade and therefore trade liberalization significantly improves economic growth. Many countries especially those of South-East Asia have attained significant growth rates which are partly attributed to their trade policies. Evidence from countries such as India and China also shows that economic growth has led to significant declines in poverty levels. Many African countries including Ghana have liberalized their trade regimes. Meanwhile trade liberalization has benefited some countries but the same cannot be said of many African countries. It is recognized that the extent of trade liberalization differs among groups of countries and countries in the same group due to structural and economic peculiarities. Thus, a specific country analysis of the trade liberalization is justified to have a better understanding of the impact of trade liberalization on GDP growth in individual countries. Thus, the impact of trade liberalisation on economic growth may not necessarily be unambiguous in terms of country specific studies. This has called for the need to investigate the impact of trade liberalization on Ghana’s economy through examination of the trends in trade openness and real GDP growth.

The specific objectives of the study were to examine the trends of liberalization and GDP growth rate over the period 1984 to 2011, to examine the relationship between trade 62


liberalisation (ratio of export and import to GDP) and the economic growth, and to make recommendations to policies makers on the effects of trade liberalisation and economic growth policy on the country.

Based on these objectives, co-integration and VECM were employed appropriately to incorporate recent developments in time series modelling which goes beyond the traditional regression problems of autocorrelation, multicollinearity and simultaneity. The study considered the dynamic specification of the series and a co-integration test has to be conducted. ADF and Phillip-Perron tests were used to establish stationarity to ensure that results are appropriate for policy recommendations. Following Johansen (1988) researchers use ADF and PP method of differencing to deduce the order of co-integration of their time series data. Again, an Error Correction Model (ECM) to capture possible long run information that might have been lost in the course of differencing was achieved.

The findings showed that the economy experience remarkable increase in real GDP growth from 1984 onward. On the average real GDP is growing by 5.3% from 1984 to 2011. The relatively high levels of trade liberalisation are associated with higher real GDP growth and for that matter economic growth. Average openness was 46.9% during the 28-year period under consideration.

The findings also show that both the Augmented Dickey Fuller and Phillip -Perron tests are superior at their first differences and thus, the study could rely on the test results as the basis for investigating co-integrating relationship between the variables. The economic variables share a long-run equilibrium relationship implying that over long 63


period of time the variables will not move independently of each other but rather are linked in the long-run. In the long run, the effects of the explanatory variables have relationship with economic growth. Trade liberalization in the long run can be the engines that would foster the needed technological progress and makes it possible for Ghana to access intermediate inputs and technology transfer from more advanced countries, promotes exports through export led growth and thus generates positive spillovers through exploiting scale economies, and encourages competitiveness and efficiency in both domestic and international markets. This has been consistent with the study conducted by Sakyi (2010) and Balassa (1978).

The results show that short-run dynamic economic growth adjusts by the speed of 51.03% to obtain equilibrium in the event of shocks in the economic system. There is a relationship between the variables, that is, any short run disequilibrium in the relationship will revert to equilibrium. The result also suggests in the short run, changes in key determinants of growth have significant impact on economic growth. It also shows that in the short run a unit increase in trade openness/liberalisation would lead to insignificant increase of about 0.47% in GDP growth as a measure of economic growth. A percentage increase in real exchange rate would cause economic growth to rise by 81.80%. This supports the fact that, devaluation of Ghana’s currency is making exportable products cheaper in the sights of foreigners so that more of domestic products can be bought by them. In the short run when inflation rate increases by one percent, economic growth would increase by 0.11%. A percentage increase in the ratio of FDI to GDP would cause economic growth to decline by 57.03%. In the short run, contribution of FDI to GDP is

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predicted by theory to enhance economic growth due to the fact that FDI flowed from developed countries to Ghana through multinationals to create multiple effects.

The study found that trade openness, real exchange rate and foreign direct investment have positive correlation with economic whilst there is a negative correlation between inflation rate and economic growth. However, the results of pairwise Granger causality test and indicate that, there is no causality between trade liberalisation and economic growth. The results show that there is causality between real exchange rate and economic growth - that real exchange rate have influence on economic growth. Inflation does not granger cause economic growth as expected because there should be negative relationship whilst FDI Granger causes economic growth. Real exchange rate has a causal relationship with trade openness. This implies that, real exchange rate influences trade liberalisation. Similarly, inflation and FDI Granger cause trade liberalisation and thus implies they have influence on trade liberalisation.

5.2

Policy recommendations The effects of trade liberalisation are at the centre of a continuing controversy in the economic transformation of Ghana. Many economists believe that the impact of trade openness on economic growth is positive. From the analysis so far, it follows that a lot of effort ought to be done to maximise the benefit of trade openness and hence the following recommendations are necessary:

The openness variable has a positive impact on economic growth both in the long run and short run but short run effect is insignificant. This implies that trade liberalization with the aim of promoting trade export-led growth will in the short run increase the rate of 65


growth of GDP. In the long run, trade liberalization will be growth enhancing while in the short run it is slightest. Therefore, trade liberalization policy implementation should be encouraged in order to get the long run benefit to the economy. Ghana’s growth objective through export-led growth is likely to be effective because in the long run trade liberalization would be favourable. Thus Export promotion should be highly intensified as part of the trade liberalization policy. This can take the form of regularly organizing trade fairs at least every quarter in the year.

In addition, there should also be diversification of our exports in terms of the base and adding value to the existing ones as well as expanding market destinations. There should also be rural trade fairs and exhibitions at the district level to encourage Ghana made products and services. This may reduce domestic expenditure on imported goods and services and thus ensure favourable balance of trade leading to high economic growth.

The study also showed a positive relationship between real exchange rate and economic growth. Therefore, it should be noticed that, the balance of payments problems responded to by taking direct control of the supply of foreign exchange through surrender requirements and then imposing a variety of restrictions on the access to that foreign exchange, including import licensing and quota restrictions on imports. These policies do succeed in defending the exchange rate, but at the cost of sacrificing the benefits of free international trade and suffering the arbitrary allocations of foreign exchange and the accompanying rent-seeking that control systems often entail. Free trade is healthy for Ghana’s growth which the study agrees and this agreement explains the widespread support for devaluation in a typical developing country with balance of payments 66


problems. If Ghana wishes to relax or remove its foreign exchange rationing scheme it must rather devalue to eliminate excess demand for foreign exchange. Because this study strongly opposes exchange restrictions, since it correlates with economic growth, devaluation is suggested for the growth of the economy.

There was a positive and significant relationship between inflation rate and economic growth from both short run error correction model and long run cointegration results. This means that some level of inflation rate is required for economic growth to be accelerated.

In addition, an interesting result of the study which informs a policy recommendation targeted to enhancing economic growth is the negative relationship between contribution of FDI to GDP and economic growth. This is a clear manifestation of the overconcentration of FDIs in a few sectors of the economy mainly mining and construction sectors. In addition the inflow is not enough to effect the necessary desired economic growth. For this reason, government can encourage and indirectly shift attentions of foreign investors to go into the industrial and agricultural sectors that could be growth enhancing. This can be done through conducive and investor friendly environment created in the manufacturing and agricultural sectors of the economy so as to attract foreign investors into those sectors. These may include tax holidays and tax relieves to investors who wish to go to these sectors as well as improvement in the infrastructural base of the country such as roads, communications, among others particularly in the rural areas. Review of the land tenure system to avoid cumbersome process of acquiring land can also help attract investors into the agriculture sector. All 67


these are intended to supplement domestic investment in those sectors so as to accelerate economic growth.

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Impact of Trade Liberalisation on Economic Growth in Ghana