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Economic Development andInternational TradeDr. Ashfaque H Khan Chief of Research a & Dr. NajamSaqib Research Economist aa Pakistan Institute of Development EconomicsPublished online: 28 Jul 2006.

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INTERNATIONAL ECONOMIC JOURNAL Volume 7, Number 3, Autumn 1993

EXPORTS AND ECONOMIC GROWTH: THE PAKISTAN EXPERIENCE

ASHFAQUE H. KHAN AND NAJAM SAQIB*

Pukistun Institute of Development Economics

The relationship between exports and economic growth has been examined extensively in recent years for a variety of countries. These studies suffer from two shortcomings. First. using cross-country data these studies assume similar technology across the countries. Second, ignoring simultaneity between exports and economic growth their parameter estimates-are biased and inconsistent. ~ h i s - ~ a ~ e r examines the relationship between these two variables in a simultaneous equation framework and uses ~ S L S technique. Not only a strong positive association between exports performance and economic growth is found but more than 90 per cent of the contribution of exports to economic growth is indirect in nature. [F 141

1. INTRODUCTION

The relative merits of alternative development strategies involve either import substitution or export promotion has been a subject of considerable debate among academics and policy makers in recent years.' A consensus was evolved in favour of export promotion during the 1970s because of the view that such policies would lead to efficient resource allocation, greater capacity utilization, permit the exploitation of economies of scale, generate technological improvement in response to competition abroad and, in labour-surplus countries, contribute to increase employment (Balassa, 1978: 180).

Such an advocacy for export oriented policies has not been immune from criticism. Recently it has been argued that there are reasons for export pessimism as far as developing countries are concerned. The slowing down of economic activities in the industrialized countries implies that the trade engine is running out of fuel. The alternative source of fuel has to be found to drive the trade engine through more South-South trade.2 Balassa (1985) has however, reaffirmed the virtues of export oriented policies for developing countries even in the face of sluggish economic activities in the industrialized countries.

*The authors are grateful to Professors Lawrence R. Klein and Syed Nawab Haider Naqvi; Peter Nunnenkamp, Tayyeb Shabir, Nadeem Burney and three anonymous referees for their comments on the earlier drafts. They also thank Mohammad Akmal for research assistance beyond the call of duty and Mahboob Iqbal for tying the manuscript. They bear sole responsibility for the paper's deficiencies.

'See Bhagwati (1988) for a detailed discussion on this issue. 'For such view see Reidel (1988). Bhagwati (1988) reports some new studies that present

new arguments in defence of import substitution.

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A. H. KHAN AND N. SAQIB

For developing countries the ability to expand productive capacity hinges on the ability to import industrial raw materials and capital goods. The ability to import these items depend directly on the ability to export, given the assumption that more foreign exchange cannot be obtained from foreign borrowing. Hence, exports are key to the growth in developing countries. It is because of this fact as well as the success of export promotion policies in many developing countries that led to the extensive investigation of relationship between exports and economic growth in recent years (See for example, Michaely, 1977; Balassa, 1978, 1985; Krueger, 1978; Tyler. 1981; Feder 1982; Kavoussi, Kavoussi, 1984; Ram, 1985; Chow, 1987; and Fosu, 1990). All of these cross-country studies confirm a strong positive association between exports and economic growth.

In measuring the relationship between exports and economic growth, generally three types of approaches have been followed. While Michaely's (1977) evidence is purely based on simple Spearman rank correlation, the other study such as Balassa (1978) has used an export-augmented neoclassical production function in addition to Spearman rank correlation method. Jung and Marshall (1985) and Chow (1987) have applied Granger and Sim's causality tests to determine the direction of causation between exports and economic growth. These studies, though contribute significantly in explaining inter-country differences in GNP growth rates, they suffer from at least two short-comings. First, since all these studies are based on cross-country data the parameters estimated are assumed in some general way similar across countries. Furthermore, most of these studies have estimated a production function and hence have assumed similar technology across the countries. Secondly, the parameters obtained by the OLS technique are biased and inconsistent because of the simultaneity between export (independent variable) and GNP growth (dependent variable). Ignoring simultaneity problem may in part understate the contribution of export expansion on economic g r ~ w t h . ~

The present study takes into account the above shortcomings by examining the export-economic growth relationship for a developing country like Pakistan using time-series data for the period 1 9 7 2 - 8 8 . 9 simultaneous equation model comprising of equations for export and economic growth is developed. Considering the fact that Pakistan is a developing country and still rely to a large extent, on primary commodities export (average 37 percent during the sample period), our total export are then divided into primary and manufactured exports as well. The model is estimated by Three Stage least Squares (3SLS) - a Full Information estimation technique. The rest of the paper is organized as follows: The structure of the model as well as data are discussed in section 2. Results are presented in section 3 and the final

3Ty1er (1981), Jung and Marshall (1985), and Ram (1985) have acknowledged the existence of simultaneity problem and have suggested the use of a simultaneous equation model. They, however, did not specify a simultaneous equation system because it was considered as "beyond the scope of the paper."

'Bhagwati (1988) has pointed out that relatively speaking, detailed country studies are methodologically superior and more persuasive.

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EXPORTS AND ECONOMIC GROWTH

section contains concluding remarks.

2. THE MODEL AND DATA

In order to examine the relationship between exports and economic growth we need equations for these two variables. Following Balassa (1978) and Tyler (1981) we specify an export augmented Cobb-Douglas production function such that

where y is gross domestic product; L is employed labour force; K is capital stock; X is real value of exports and A is efficiency parameter.

Besides labour and capital, the third factor, exports, is included in the production function for the following reasons. First, export expansion allows the home country to concentrate investment in those sectors where it enjoys a comparative advantage. This results into specialization which is likely to augment overall productivity. Second, production for larger international market permits economies of scale to be realized in the export sector. Third, it generates technological improvement in response to competition abroad which is likely to reduce inefficiencies in the overall traded-goods sector. Finally, export expansion would enhance a country's ability to import more physical and human capital, including advanced technologies in production and management. Thus, exports as production input is intended to reflect the above mentioned factors that influence productivity but are not captured in labour (L) and capital (K). Taking logarithmic transformation to linearize eq. (1) we have

lny = l n A + a , l n L + a , l n K + a , lnX+u (2)

In specifying an export function the prevailing practice has been to specify an export demand or export supply function. However, the dominant view has been in favour of an export demand function^.^ In recent years, Goldstein and Khan (1978) have argued in favour of specifying export demand and export supply functions simultaneously on the grounds that the relationship between quantities and prices is simultaneous. Balassa, et al. (1989) have, in fact, estimated export demand and export supply functions simultaneously for countries such as Greece and Korea for the period during which these two countries were regarded as developing countries. Hence, simultaneous estimation of export demand and export supply functions offers an interest in our case as well.

The export demand function is specified to depend upon foreign income and relative price variables. The world GDP index (Y,) is used to represent foreign income while the relative price variable is defined as the ratio of the index of domestic export prices [P,($)] to world export prices [P,($)], both expressed in terms of U.S.

3ee Goldstein and Khan (1985).

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56 A. H. KHAN AND N. SAQIB

dollars. Using Cobb-Douglas functional form export demand is specified as

where Xd is real value of exports demanded; and C is efficiency parameter. The choice of the particular functional form is made because of the ease in

interpretation of the result. Taking logarithmic transformation to linearize eq. (3) we have

where p, and 0, are respectively foreign income and relative price elasticities. It is

expected that P, > 0 and P, < 0. The export supply function is specified to depend upon domestic production of

exportable and relative price ~ar iab le .~ The gross domestic product (Y) is used to represent domestic production of exportable and relative price variable is defined as the ratio of the index of Pakistan's export prices [P,r($)] (incorporating changes in the dollar prices of exports, the exchange rate and export subsidies) to the domestic price level. (P,) Again using Cobb-Douglas functional form the export supply function is specified as

where XS real export supply; eR is index of effective exchange rate; and Z is efficiency parameter. Taking logarithmic transformation to linearize equation (5) we have

where y, and y, are respectively domestic income and relative price elasticities. It is

expected that y, > 0 and y, > 0. Assuming equilibrium in the export sector we have Xd = F = X. Thus, equations ( 2 ) , (4) and (6) form a system of simultaneous equation which are to be estimated simultaneously to examine the relationship between exports growth and income growth. It can be seen that unlike other studies, exports are not treated as purely exogenous rather it is determined simultaneously by the combination of both domestic as well as foreign sector.' As mentioned earlier, we disaggregate

60ne of the referees suggested to redefine the export supply function as an excess supply function of exportable, i.e., the difference between supply and demand of exportable. Given the data available for exports it is not possible to quantify excess supply of exports.

'Following Goldstein and Khan (1978) we also normalized export supply function such that

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EXPORTS AND ECONOMIC GROWTH

total export into primary and manufactured exports and measure their relations with growth using the three equation mentioned above.

A few words regarding the choice of estimation technique are in order. It is clear that the use of the Ordinary Least Square (OLS) to estimate the system of simultaneous equation would yield biased and inconsistent estimates. Hence we use the method of Three-Stage Least Squares (3SLS)-- a full information method as opposed to Two Stage Least Squares (2SLS) because it estimate the system of simultaneous equation together rather than each equation ~eparately.~ The 3SLS is relatively more efficient as compared to 2SLS if the model is correctly specified because it uses information on the correlation of the stochastic disturbance terms of the structural equations to improve asymptotic efficiency.

Before we close this section a few words regarding data and its sources are in order. The data corresponding to gross domestic product at current prices are taken from the Statistical Supplement: Pakistan Economic Survey 1988-89, Table 2.7, pages 30-31, published by the Economic Adviser's Wing, Finance Division, Government of Pakistan. These are then deflated by the GDP price index at the 1969-70 base period to get the real GDP. The GDP price index is constructed by taking the ratio of GDP at current and constant prices. GDP at constant price is taken from the above mentioned publication, Table 2.2 from pages 24-25. The data regarding the value of exports are taken from the above mentioned source, Table 10.4, page 146. These are converted to the real value of exports at 1969-70 prices by dividing through unit value index of exports which are also taken from the same source, Table 10.3, page 145. As regards the labour force employed, these are also taken from the above mentioned source, Table 1.9 Page 15, Column 5. The data regarding the index of world GDP, index of dollar export prices of Pakistan as well as of the world are taken from the International Financial Statistics Year Book 1990, International Monetary Fund, Washington, D. C. The data for the effective exchange rate are taken from Dorosh and Valdes (1989).

Finally, since data regarding the capital stock are not available from amy published sources because of its inherent difficulties in measurement we attempt to construct our own series using the formula

K, = I, + (1 - 6)K,-, (7)

Eqs. (2), (4) and (6") form a system of simultaneous equation and were estimated simultaneously but the results obtained were not satisfactory. These results, are however, available with the authors.

*At the suggestion of the referees, we, in fact, performed Hausman (1978) specification test for testing the hypothesis of no misspecification in the model. Let H , denote the null hypothesis that there is no misspecification of the model and let H, denote the alternative hypothesis that there is misspecification of the model. The test statistics X2 is found to be 8.43.

If we assume a = 5 percent, the critical X9alues at three degrees of freedom (k = 3) are 0. 215795 and 9.34840. Since the computed X2 lies between these limits, the data support the null hypothesis and we may accept it.

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5 8 A. H. KHAN AND N. SAQIB

where K, is capital stock at the end of period t; I, is gross investment in constant prices

during period t; 6 is capital consumption (depreciation) in period t; and K, , is capital stock in period t - 1. In the construction of capital stock series we need two important information i.e., information about the initial or base year capital stock and the rate of depreciation. In order to get the initial or base year capital stock, we have used the method of Harberger (197Q9

As regards the depreciation rate, following Khan (1988), we have used 5 percent rate of depreciation in this paper. Once the initial or base year capital stock is obtained, it then become straight forward to derive capital stock series using eq. (7). The data corresponding to gross investment (I,) is taken from the Statistical Supplement: Pakistan Economic Survey 1988-1989, Table 2. I, page 23.

3. RESULTS

Having discussed the model, estimation technique and data in the preceding section we now present results. As pointed out at the outset that earlier studies have ignored the simultaneity problem between exports and economic growth and estimated parameters by the OLS technique which are bound to be biased and inconsistent. Furthermore, we claim that ignoring such problem may, infact, have understated the contribution of export expansion on economic growth. To prove our assertion we begin by estimating an export- augmented production function [eq 21 using the OLS technique. The results corresponding to the impact of total, manufactured, and primary exports on economic growth are reported in Table 1.

Table 1. OLS Estimates of Export-Augmented Cobb-Douglas Production Function

In y = - 11.54 + 0.58111 L + 1.73111 K + 0.041nX (3.60)* (2.07)* (4.94)* (0.72)

R2 = 0.98, DW = 1.52, SER = 0.02

In y = - 10.7 1 + 0.48111 L + 1.661n K + 0.07111 Xrn (3.59)* (1.84)* (5.30)* (1.33)

R2 = 0.98, DW = 1.63, SER = 0.02

-

R2 = 0.98 DW = 1.52; SER = 0.02

Note: Xrn = Manufactured goods exports Xp = Primary goods exports t-statistics in parenthes *denotes significance at 5 percent level.

It can be seen from the table that the size of the regression coefficients of export variables range from 0.03 in the case of primary exports to 0.07 in the case of

9The detailed mechanics of deriving initial or base year capital stock are avoided here to conserve space. However, these are well documented in Harberger (1978: 15-40).

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EXPORTS AND ECONOMIC GROWTH

manufactured exports with total exports taking the middle ground (0.04). These coefficients are close to the ones reported by Balassa (0.04), Krueger (0.06) and Tyler (0.057). What we have showed here is the fact that if we also ignore simultaneity between exports and economic growth we get the size of export coefficients which are close to the ones reported in the literature. Having said this we now turn to present the results corresponding to the relationship between total, manufactured and primary exports and economic growth using the 3SLS technique. The results are reported in Table 2.

Turning first to the relationship between total exports and economic growth, it can be seen from Table 2 that all the coefficients bear expected sign and are statistically significant at the 5 percent level of significance with the exception of the coefficient of the relative price in export supply function. The regression coefficient of the export variable in eq.(2) in Table 2 is considerably higher (0.31 as opposed to 0.04 when simultaneity is ignored) and is statistically significant with the positive sign. This implies a fairly large response of GDP growth to changes in exports expansion.I0 Thus, a strong association is found between exports performance and GDP growth in the case of Pakistan. This finding strongly support our claim that ignoring simultaneity between and economic growth understate the contribution of export expansion on economic growth.

As regards the export demand equation [eq. (4)], the foreign income elasticity of the demand for exports is 1.69 which suggest that Pakistan's exports are highly responsive to changes in the world GDP index. The price elasticity of export demand is 0.24 which point to an important role for relative prices in determining the world demand for Pakistan's exports. The domestic income elasticity in the export supply function [eq. (6)] is close to unity. A comparison of two income elasticities suggests that Pakistan's exports are more dependent on world rather than on domestic economic activity.

The results corresponding to the relationship between manufactured exports and income growth are reported in Table 2. Like the case of total exports all the coefficients bear expected signs and are statistically significant at the 5 percent level of significance with the exception of the coefficient of relative price in export supply equation. The coefficient of manufactured exports in the production function [eq. (2)] is statistically significant with the positive sign. Once again, a strong association is found between the manufactured export performance and GDP growth. Like in the previous case when simultaneity problem. The foreign income elasticity of the demand for manufactured exports 2.32 which suggests that Pakistan's manufactured exports are highly responsive to changes in the world GDP index. The price elasticity of the demand for manufactured exports is 0.38 which is considerably higher than the one reported with respect to total exports. Hence the manufactured exports are found

I0The readers are reminded of the fact that exports as such do not shift directly the production function upward rather it is used as proxy variable which represents the effects of all those non-quantifiable factors mentioned earlier. Hence, the larger response of GDP growth to changes in exports are the result of the combined effect of factors mentioned earlier.

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60 A. H. KHAN AND N. SAQIB 1

to be highly sensitive to price changes.

The domestic income elasticity of the supply of manufactured exports [eq. 61 is 1.6 which is considerably higher than the one reported for total exports. Once again, a comparison of two income elasticities suggests that Pakistan's manufactured exports are more responsive to foreign rather than domestic income. The results corresponding to the relationship between primary exports performance and income growth are also reported in Table 2. All the coefficients bear expected signs and are statistically significant at the 5 percent level of significance with the exception of relative price variables in both the export supply and export demand functions. The coefficient of primary exports in the production function is reasonably high (0.25) which implies a fairly high response of GDP growth to changes in primary exports. Once again, when the problem of simultaneity is taken into account the contribution of primary goods exports on income growth increase from 0.03 to 0.25. It is interesting to note that the size of the contribution of primary export expansion is much higher than the manufacturing exports on Pakistan's GDP. This is consistent with the fact that during the period under study Pakistan has relied more on primary goods exports. The foreign income elasticity of demand for primary exports is almost

I

Table 2. Estimates of Relationship Between Exports and Economic Growth: Results from 3SLS

Relative Price [p,($). eRI/P, - R2

DW

SER

Variables

InterceptTerm

Labour (L)

Capital (K)

Exports (X)

World GDP Index (Yw)

Relative Price

0.10 0.13 0.34 (0.20) (0.82) (1.10)

0.99 0.82 0.84 0.99 0.92 0.94 0.97 0.45 0.41

1.89 1.63 1.63 1.48 1.41 1.63 1.76 1.72 1.66

0.03 0.03 0.03 0.02 0.02 0.03 0.04 0.03 0.03

Total Exports Manufactured Exports Primary Exports

Eq.(2) Eq.(4) Eq.(6) Eq.(2) Eq.(4) Eq.(6) Eq.(2) Eq.(4) Eq(6)

-3.44 -0.18 -3.85 -6.76 -4.18-11.05 -6.93 2.06-4.65 (1 .OO) (0.13) (1.44)* (3.73) (3.08)* (6.27)* (4.07)* (0.79) (0.92)

0.86 0.68 0.96 (7.10)* (3.45)* (8.42)*

0.78 1.23 1.11 (2.07)* (7.40)* (5.81)*

0.31 0.14 0.25 (2.78)* (1.87)* (4.56)*

1.69 2.32 1.03 (5.99)* (8.50)* (1.94)*

- 0.24 - 0.38 - 0.04 [px($)/Pw($)l (2.85)* (5.17)" (0.39)

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EXPORTS AND ECONOMIC GROWTH

unity while the domestic income elasticity of supply of export is less than unity (0.92). The relative prices in both the export supply and demand functions, though bear expected sign, fail to reach the significance level.

Following Balassa (1978) we also examine the relationship between exports and the growth of GDP net of exports. The relationship between these two variables may be taken to reflect the indirect effects of exports on income growth. The results of this exercise corresponding to total, manufactured, and primary exports are reported in Appendix Table 1. Not surprisingly, a slightly weaker relationship is obtained in regard to the indirect - as compared to the total effects of exports. The size of the coefficient of exports is 0.28 which is slightly less than 0.31 reported in the case of total effects in Table 2. Similarly, the size of the coefficients of manufactured and primary exports are respectively 0.12 and 0.24 which are slightly less than 0.14 and 0.25 reported in the case of total effects in Table 2. What is interesting to note is the fact that more than 90 percent of the contributions of exports (manufactured and primary as well) on economic growth are indirect in nature. This is consistent with the fact that exports affect economic growth through efficient resource allocation, greater capacity utilization, exploitation of economies of scale and technological improvements in response to competition abroad. Rest of the results, however, remained almost unchanged and therefore, interpretation is avoided for the sake of repetition.

4. CONCLUDING REMARKS

The purpose of this paper has been to examine the relationship between exports performance and economic growth. Unlike other studies on this topic the present paper has examined the relationship in a simultaneous equation framework. The influence of exports on economic growth has been measured by specifying an export- augmented neoclassical production function. Exports on the other hand, havc been determined by the combination of both the domestic and the foreign factors. Besides total exports, this paper has taken the analysis down to the level of manufacturing and primary goods exports and examined their relationship with economic growth. Furthermore, attempt has also been made to measure the indirect effects of exports on economic growth by estimating the relationship between export performance and the growth of GDP net of exports. The Three Stage Least Squares (3SLS) technique has been employed to estimate the system of simultaneous equation.

This paper finds a strong association between export performance and GDP growth and hence, provides support to earlier studies. It also shows that if we ignore simultaneity between exports and economic growth the contribution of exports expansion on GDP growth is understated. Further disaggregation reveals that the marginal contributiori of primary goods exports on GDP growth is higher compared to manufacturing exports. This is consistent with the fact that Pakistan has been relying more on primary goods exports during the period under study. This paper also find that more than 90 percent of the contribution of exports on economic growth is

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62 A. H. KHAN AND N. SAQIB

indirect in nature in Pakistan. The foreign income elasticity of demand for exports is found to be much higher

compared with the domestic income elasticity of supply of exports. This finding indicates that Pakistan's exports are more responsive to changes in foreign income rather than in domestic income. Furthermore, the foreign income elasticity of the demand for manufactured exports is found to be considerably higher than the demand for primary goods exports. Given these two information it is suggested that Pakistan should orient their exports towards manufactured goods. Furthermore, the evidence of strong association between exports and economic growth in the paper advocates for an open development strategy emphasizing export-orientation rather than import sub- stitution.

Appendix Table 1. Estimates of Relationship Between Exports and GDP Growth Net of Exports: Results from 3SLS

Variables

Intercept Term

Labour (L)

Capital (K)

Exports (X)

World GDP Index (Yw)

Relative Price [PX($)/P,($)l

GDP(Y)

Relative Price

[P,($). eRl/P, -

R2

DW

SER

Total Exports Manufactured Exports Primary Exports

Eq.(2) Eq.(4) Eq.(6) Eq.(2) Eq.(4) Eq.(6) Eq.(2) Eq.(4) Eq(6)

-3.73 -0.16 -3.81 -6.99 -4.23-11.63 -7.11 2.07-4.49 (1.02) 0 . 1 1) (1.35)* (3.73)* (3.13)* (6.14)* (0.08) (0.80) (0.87)

0.90 0.70 0.98 (7.03)* (3.50)* (5.75)*

0.81 1.26 1.13 (2.03)* (7.31)* (8.36)"

0.28 0.12 0.24 (2.36)* (1.56)** (4.24)*

1.68 2.33 1.03 (5.95)* (8.55)* (1.95)*

- 0.24 - 0.38 - 0.04 (2.86)* (5.16)* (0.40)

1.03 1.62 0.91 (7.16)* (12.72)* (2.59)*

1.10 0.14 0.33 (0.20) (0.85) (1.05)

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64 A. H. KHAN AND N. SAQIB

(ed.), Economic Development and International Trade, London: Macmillan, 1988, 25-54.

Tyler, W. G., "Growth and Export Expansion in Developing Countries," Journal of Development Economics, August 198 1, 121 - 130.

Mailing Address: Dr. Ashfaque H . Khan, Chief of Research, Pakistan Institute of Development Economics, P. 0. Box 1091, Islamabad, Pakistan. Mailing Address: Dr. Najam Saqib, Research Economist, Pakistan Institute of Development Economics, P. 0. Box 1091, Islamabad, Pakistan.

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