An Empirical Note on the Export-Led Growth Hypothesis: The Case of Malaysia*

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AN EMPIRICAL NOTE ON THE EXPORT·LED GROWTH HYPOTHESIS: THE CASE OF MALAYSIA' Mansor H. Ibrahim Department of Economics International Islamic Universiiy Malaysia

The present empirical note re-examines the export~led growth hypothesis for the case of Malaysia. Using standard procedures of unit root testing, cointegration and error correction modelling, we find evidence for hi-directional causality between exports and real output per capita. Addressing the issue of exogeneity, we test for weak exogeneity and super exogeneity of exports within the error correction framework. We find evidence that exports are not weakly exogenous and subsequently, are not super exogenous. This result weakens the case for the export-led growth hypothesis. In the Malaysian context, the Lucas critique applies, namely, that the relationship between expons and real output per capita is not invariant to policy changes or regime shifts.

1.

INTRODUCTION

An important economic growth policy recommendation for developing countries is to increase exports, which is known as the export-led growth (ELG) hypothesis. According to the hypothesis, export expansion can encourage growth through various channels. These include increased efficiency and productivity through specialization in areas with comparative advantages and more efficient management styles, greater economies of scale resulting from expanding market size, and improved techniques of production and heightened technological progress due to increasing competition. These accrued benefits to the economy are generally viewed to outweigh the costs that certain sectors of the economy may have to bear. For instance, in a developing economy, the export promotion strategy tends to favor the manufacturing sector at the expense of a more traditional sector such as the agricultural sector through re-allocation of resources and policy incentives. Moreover, some non-viable or initially protected industries may not survive

increasing competition from intemalional trade. Despite these possible costs, the net benefits of export promolion strategy are generally considered 10 be positive. Empirically, the ELG hypothesis has been intensively tested for developing economies. l In the context of the Malaysian economy, there are several studies that I would like to thank the referee of this Journal for comments and suggestions, which greatly improved the paper. I however, remain responsible for any errors and omission. See Ghalak et al. (1997), and Baharumshah and Rashid (1999) for a review of the

literature.

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attempt to identify the causal nexus between export growth and economic growth, either by focusing specifically on Malaysia or by having Malaysia as a country in

their sample. These studies include those by Dodaro (1993), Bahmani-Oskooee and Asle(l993), Ahmad and Hamhirun (1995), Doraisami (1996), Ghataketal. (1997), AI-Yousif (1999), and Baharumshah and Rashid (1999). While evidence for the ELG hypothesis from early studies seems mixed, the results from later studies are promising. In particular, Dodaro (1993) notes a negative impact of export growth on Malaysian economic growth. Meanwhile, Bahunani-Oskooee and Asle (1993) and Ahmad and Hamhirun (1995) find no long run relationship between real gross domestic product and real exports. Doraisami (1996) however, finds evidence for bi-directional causality between the two variables. The recent time-series studies for Malaysia by Ghatak et al. (1997), AI- Yousif (1999), and Baharumshah and Rashid (1999) find supportive evidence for the ELG hypothesis. In their study, Ghatak et al. (1997) extend the previously used bivariate framework on several fronts. First, they consider amultivariateframework consisting

of real output, real exports, and capital (physical and human). They also utilize disaggregated export measures such as manufactured products, fuel products and non-fuel primary products in the analysis. Lastly, they consider both real GDP and real non-export GDP as real outpUI. Applying standard procedures of unit root testing, cointegration, and causality tests using annual data from 1955- I 990, they provide supportive evidence for the ELG hypothesis. Moreover, according to their results, manufactured exports seem relatively more important than traditional

exports in driving Malaysian economic growth. AI-Yousif (1999) evaluates the ELG hypothesis in a five-variable framework, which includes real GDP, real exports, employment index, real gross fixed capital formation, and real exchange rates, using annual data from J955- J996. Applying cointegration and error correction modelling, he documents evidence supporting the role of exports in Malaysian economic development in the short run but in the

long run, real output seems to lead real exports. Baharumshah and Rashid (1999) further substantiate the important role of exports in trivariate framework, which also includes real imports. Specifically, they find the causal nexus between real export growth and real output growth to be bi-directional using quarterly data from

1970 to 1994. The purpose of the present paper is to re-examine the ELG hypothesis for Malaysia. The analysis here, takes the seminal empirical study ofLevine and Renelt (1992) as a point of departure. The growth equations used in Levine and Renelt (1992) specify the growth rate using real output per capita while the export measure is the ratio of exports to GDP. From their sensitivity analysis, they note that, among

a variety of economic, political, and institutional variables, only the share of investment in GDP has a positive and robust relationship with economic growth.

Other variables including export ratios, however, are fragile determinants ofoutput growth. That is, the significance of the variables depends on which variables are included as conditioning variables. These findings provide strong empirical justification for including investment rate a priori as a determinant of economic growth. Moreover, as noted by Alexander

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(1997), the atheoretical nature of most empirical studies, which are based on Granger causality tests and recently on cointegration and error correction models, does not justify omitting the central theoretical determinant of growth, i.e. the investment rate. Except for Ghatak et al. (1997) and AI-Yousif (1999), existing studies ignored the investment rate in their analyses of the Malaysian output growth - export growth causal nexus. Thus, as our basic framework, we use a trivariate model consisting of real GOP per capita, investment share in GOP and ratio of exports to GOP. While most existing studies utilize real GOP, we follow Levine and Renelt (1992) in using real GOP per capita as a measure of real output. This has a foundation in the neoclassical growth theory recently revived by Mankiw et al. (1992) whereby they derive a steady state of real output expressing real output per worker as a function of investment rate and labor growth rate. In our analysis, we also allow for two additional explanatory variables that are viewed to be important determinants of Malaysian economic growth. These are imports and government expenditures. Having relied mainly on commodity exports since its independence in 1957, Malaysia shifted its emphasis towards industrialization during the 1980s. This has made Malaysia highly dependent on imported intermediate goods and capitals. The Malaysian government has also been actively involved in the nation's development process especially since the inception of the New Economic Policy (NEP) in 1970. While the inclusion of these two variables enable us to empirically examine their importance, our primary intention is to assess the robustness or fragility of the export ratio in explaining economic growth. Moreover, their inclusion may alleviate the potential problem of omitted variable bias. In line with recent studies, the present analysis utilizes standard procedures of unit root testing, cointegration and error correction modelling. However, while existing studies focussed mainly on the causal nexus among the variables using the notion of Granger causality, the present study has a focus instead on the issue of "exogeneity". This issue is highly essential for the validity of the ELG hypothesis· as a policy prescription for attaining growth. More specifically, to make a strong case for export promotion strategies, exports need to be super-exogenous. According to Engle et al. (1983), the concept of super-exogeneity is closely related to the Lucas (1976) critique. The super-exogeneity ofexports means that export promotion policies are structurally invariant to structural changes or regime shifts. To ascertain this, we implement exogeneity tests within the error correction framework. The rest ofthe paper is structured as follows. In the next section, we present the preliminary analysis of the data. Section 3 estimates the error correction models and discusses the exogeneity tests for the variables in the system. Lastly, section 4 concludes. 2.

PRELIMINARY ANALYSIS

2.1 Data The analysis employs annual data obtained from the International Financial Statistics Yearbook for the period 1960-1997. We use real GOP per capita (y) to measure real output. This is obtained by adjusting nominal GOP by mid-year

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estimates for population and the consumer price index (CPl). We use gross fixed capital fonnation as a share of GDP (s) to measure investment ratio. Similarly,

exports (x), imports (m), and government consumption (g) are also expressed as ratios of GDP. All the variables are expressed in natural logarithm form. To evaluate the export-led growth hypothesis, we fIrst estimate a basic model consisting ofreal GDP, investment ratio and export ratio. We then expand the model to include both import ratio and government consumption ratio. Table I provides average values of these variables over the sample period. Malaysia's economic performance as reflected by the growth of GDP per capita is considered impressive. Over the period 1960-1997, the growth of GDP per capita was almost 4 per cent. During the 1960s, average GDP per capita growth was 2.6 per cent and then it increased to an impressive 5.8 per cent in the 1970s. The early 1980s however, was considered as tough years for the Malaysian economy. Due to the global recession of the early 1980s and adverse shocks in commodity prices, Malaysian growth performance plunged and as a result, average GDP per capita growth was only 1.8 per cent. Since 1987, Malaysia has recorded uninteffilpted high growth, resulting in an average growth ofGDP per capita of 5.9 per cent during 1990-1997. This high growth performance was however affected by the recent Asian fmancial crisis. TABLE 1 MEAN VALVES OF VARIABLES Variables

Y Dy s x g m Note:

1960-69

1970-79

1980-89

1990-97

1960-1997

2399.7 2.59 14.93 48.02 14.30 43.27

3633.6 5.78 23.04 46.37 16.35 42.73

5377.4 1.83 30.40 59.03 15.97 58.22

7840.9 5.90 39.14 88.42 12.88 90.64

4653.5 3.96 26.23 59.00 15.29 57.04

y is GOP per capita (millions of Ringgit in 1990 prices). Oy is the growth of real GOP per capita (%). The rest of the variables are ratios.

As can be observed from table I, over the sample period, Malaysia witnessed a continuous increase in investment ratio and an increasing importance of

international trade. During the 1960s, the investment rate was only 14.9 per cent and then it consistently increased to 23.0 per cent, 30.4 per cent and 39.1 per cent

overthe 1970s, 1980s and 1990-1997, respectively. Similarly, the ratios of exports and imports to GDP increased substantially, reflecting a shift in emphasis towards industrialization and export promotion strategies during the 1980s. This emphasis has resulted in increasing dependence on imported intennediate goods and capital. Prior to the 1980s, the ratios of exports and imports to GDP were below 50 per cent

but these ratios surpassed the 50 per cent mark during the 1980s. Over the period 1990-1997, the export ratio was 88.4 percent and the import ratio was 90.6 per cent, making Malaysia one of the highly open economies.

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The share of government consumption expenditure in GDP increased only during the 19705, coinciding with the inception of the NEP. Aiming at restructuring the economy and eradicating poverty, the NEP initiated active participation by the

government in the economic process through the establishment of non-financial public enterprises. Together with a shift towards industrialization, the government initiated privatization programs in 1983 to give the private sector an increased role in the nation's development process. Government expenditure to GDP ratio was then seen to gradually reduce, with an average ratio of about 16 per cent in the

1980s. Over the period 1990-1997, this ratio was further reduced to 12.9 per cent. 2,2 Temporal Properties of the Data Before we re-examine the ELG hypothesis, weevaluate the univariate and multivariate properties of the data series. To this end, we fIrst establish the variables' orders of

integration. Briefly stated, a variable is integrated oforder d, written I(d), ifit requires differencing d times before it achieves stationarity. To test for the integration properties of the variables concerned, we employ standard unit root tests, the augmented Dickey-Fuller (ADF) and the Phillips-Perron (PP) tests. The results from these tests for each variable are provided in the table below and it can be seen that the ADF and PPtests suggest non-stationarity of each variable when expressed in levels. TABLE 2 ADF AND PP UNIT ROOT TESTS Levels Variables y

ADF

-2.6098 -2.0302 -2.5024

s x

m

~lnl

g

-2.4860

Critical values (10% level of significance)

~3.12

pp -2.7615 -2.4534 -2.5098 -2.t406 -2.3712 -3.12

First Differences pp ADF ·3.7131' -3.9980' 3.9224' -3.3343' -3.0216 -3.12

-5.5739' -4.0118' -5.56t4' -6.62t3' -7.6052'

-3.12

Note: . denotes significance at the 10 per cent level.

Except for the government spending under the ADF test, these tests indicate that the variables under consideration are stationary in their first differences. From the results, we conclude that the variables are integrated of order I. The finding that the variables contain a unit root raises the possibility of a long

run relationship between them. Accordingly, we proceed to evaluate their multivariate temporal property using cointegration analysis. Essentially, the variables are said to be cointegrated or share a long run equilibrium if their linear combination, although they are individually non-stationary, is stationary. This means that the cointegrated variables will not drift further away from each other arbitrarily. For cointegration tests, we utilize the maximum likelihood approach of Johansen

(1988) and Johansen and Juselius (1990). The approach is essentially a vectorautoregression based test, treating all variables as potentially endogenous. The test

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is also capable of identifying multiple cointegrating vectors. Accordingly, it overcomes the inherent weaknesses of the traditional two-step Engle-Granger test. To lest for the number of cointegrating vectors, Johansen and Juselius (1990) develop two test statistics - the trace test and the maximum eigenvalue test statistics. The lag length of the tests is selected such that the residuals are serially uncorrelated. Table 3 reports the results oflhese tests. For the basic 3-variable model, the results indicate the presence of a unique cointegrating vector. The null hypothesis of no cointegration (r = 0) is rejected at the 5 percent significance level while the null hypothesis ofat most one cointegrating vector can not be rejected. Similarly, when we add both government expenditure and import ralios, both trace and maximal eigenvalue statistics at the 5 per cent significance level indicate the presence of a unique cointegrating vector among the two sets of variables. These results accord well with previous Malaysian studies (Ghatak er al., 1997, AI-Yousif, 1999, and Baharumshah and Rashid, 1999) that document evidence for cointegration in multivariate contexts. TABLE 3 JOHANSEN-JUSELIUS COINTEGRATION TESTS Test Null Hypothesis r =0 Statistics Basic Model: y, s, x Lag = 5 Trace 37.S2Y· Max 24.718"

r:5 1

r<2

12.807 12.723

0.085 0.085

20.168 15.752

9.094 9.094

rv 3

r:54

Critical Values:

Trace Max

35.068 21.894

Expanded Model: y. s, x, g. m Lag = 2 72.110" 37.023 Max 35.086" 17.780 Critical Values: Trace 75.328 53.347 Max 34.397 28.167 Note: •• denotes significance at the 5 per cent level.

Trace

3.

19.244 12.528'

6.716 6.651

0.065 0.065

35.068 21.894

20.168 15.752

9.094 9.094

ERROR CORRECTION MODELS AND EXOGENEITY

The presence ofcoinlegration among the variables under consideration implies that these variables must be temporally causally linked in at least one direction. According to Engle and Granger (1987), an error correction model (ECM) can approprialely represent the causal link among the cointegrated variables. The ECM conveniently combines variables in first differences and the error correction term to explain the dynamic behavior of a variable of interest. Using the basic 3-variabJe model, we can write the error correction model for expon ratio as:

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K

J

+

L

{3;!l Xr-l+

i: 1

L

227

L

o;Mr _;+

i= 0

L

rp;
(1)

i",O

where
(0.017)

(0.176)'

(0.219)'

(0.265)'"

(0.150)"

(0.348)"' (0.171)"

- 0.293Dx,., + 0.324ECT,., (0.157)'" (0.122)" LB; 0.05 JB; 2.175 Expanded Model: (y,

BPG; 3.868 ARCH; 0.801 RESET; 0.084 CHOW; 0.673 S,

Adjusted-R'; 004676

x, m, g)

Dx,; 0.003 + 0.516D" -00477D,, + 0.622Dm, - 0.157D" + 0.240ECT,., (00413) (0.118)' (0.073)" (0.058)' (0.097)'" (0.081)' LB; 1.59 JB ; 0.906

BPG; 4.129 RESET; 0.345

ARCH; 0.342 CHOW; 1.499

AdjuSled-R2; 0.8441

To conserve degrees of freedom, we set the possible maximum lag length at 3.

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Note: numbers in parentheses are standard errors. LB is Ljung-Box-Pierce test for serial correlation of order up to 2; BPG is Breusch-Pagan-Godfrey test for heteroskedasticity, ARCH is Engle's test for conditional heteroskedasticity; JB is Jarque-Bera test for normality; RESET is Ramsey's test for mis-specification; CHOW is Chow's test for structural stability; and ., .., and ... denote significance at the 1%,5% and 10% level respectively.

Including the government consumption and import ratios in the modelling improves the modeJ's explanatory power substantially from an adjusted R' ofOA? for the basic three-variable model to 0.84 for the expanded model. The coefficient of the error correction term is significant for both models, confirming the presence of cointegration among the variables under consideration and the long run causal nexus from the included variables to the export ratio. Note also that the coefficients of real income per capita growth are positive. These findings are in line with the view that emphasizes economic growth as providing a strong impetus for exports through the supply-side effects (Shan and Sun, 1998). We may also note from the expanded model that the coefficient of the changes in import ratio is positive and significant at the I per cent level. These results provide evidence for the "import compression hypothesis" (Khan and Knight, 1988), which highlights the importance of imports for exports while being consistent with Riezman et al. (1996) who document the importance of imports in the causal interactions between economic growth and exports. Thus, for an export-oriented economy such as Malaysia, imports of intennediate and capital goods in particular are highly essential for the promotion of exports. As we mentioned earlier, the coefficient of the error correction tenn is significant in both models. 3 Focusing on our main theme, this means that the export ratio is not weakly exogenous. Since weak exogeneity is a necessary condition for super exogeneity, the condition for exports to be super-exogenous is thus violated. To confmn this, we follow Darrat et al. (2000) by incorporating squared values of the error correction term in the export ratio equations and testing the joint significance of the error correction term and its squared values using Wald's test statistics. The test statistics were found to be significant at the 5 per cent level.' The violation of weak exogeneity and super exogeneity conditions weakens export promotion policies as a direct engine for growth. 5 In the Malaysian case, the Lucas AJ- Yousif(1999) and Baharumshah and Rashid (1999) document similarfmdings. They interpret their fmdings in terms of temporal causality among the variables.

The test statistics, which are distributed as a Chi-square distribution with 2 degrees of

freedom are 7.24 for the basic model and 8.52 for the expanded model. We thank the referee of this Journal for giving caution in interpreting the result. It is acknowledged that export promotion may work through other indirect channels in affecting economic perfonnance. The identification of these channels, however, are beyond the scope of this paper.

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critique applies. That is, the relationship between real output per capita and export ratio is not invariant to policy shifts. Accordingly, policy recommendations based on past econometric estimation using past data and assuming constant parameters is suspicious. To gain further insight on the issue of the exports - real output per capita relationship, we also estimate an error correction model for real output per capita

growth based on the expanded 5-variable model. Following a similar general-tospecific procedure, we obtain the following estimation results: Dy, = 0.027 + 0.589Ds, - 0.150Ds,.] + 0.665Dx, - 0.269Dg, - 0.532Dm, - 0.344ECM,., (0.007)' (0.116)' (0.077)'" (0.158)' (0.099)" (0.122)' (0.094)' LB

IB

=0.65 =0.500

=14.07" RESET = 1.407

BPG

ARCH =0.002 CHOW =0.991

Adjusted-R' =0.6878

where numbers in parentheses are standard errors. Overall, the error correction

model performs quite well. The diagnostic tests indicate that the model passes all tests except the heteroskedasticity test. Accordingly, the reported standard errors are corrected using White's consistent variance-covariance matrix. We may note that contemporaneous changes in export ratio enter as an explanatory variable in the error correction model of output per capita growth. Its

coefficient is positive and significant at the I per cent level. The estimated coefficient indicates that a I per cent change in the growth of export ratio leads to a 0.67 per cent change in the growth of output per capita· Referring back to export ratio regressions, we may also observe the positive effect of contemporaneous

change in the growth of output per capita on the change in the growth ofexport ratio. These results reflect contemporaneous temporal causality between export ratio and output per capita, where causation runs in both directions. The significance of the error correction term in the output per capita growth equation, apart from rejecting

weak exogeneity of real output per capita, also indicates that the two variables are causally linked to each other through their disequilibrium adjustments. Accordingly, exports and real output per capita are related both in the short run and in the long run. The significance of the error correction term also indicates that other variables in the model influence output per capita growth, suggesting adjustment in the output per capita growth in response to deviations of any variable from the long run equilibrium path. The effect of changes in investment ratio growth on real output per capita growth is positive, which is consistent with standard growth theories. Changes in government consumption ratio and import ratio enter negatively as short run determinants of real output per capita growth. The results suggest that a I per cent The interpretation of the coefficients of the output per capita growth equation reflects only immediate and direct effects of a variable of interest on output per capital growth. While we restrict our interpretation to only these immediate and direct effects, it needs mentioning that the fulJ effects of changes in explanatory variables on output growth per capita have to consider the feedback interactions among the variables through changes in the variables and the eITor correction tenn.

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change in the growth of government consumption ratio results in a 0.27 per cent reduction in real output per capita growth, while a 1 per cent change in the growth of import ratio leads to a 0.53 per cent decline in real output per capita growth. The finding ofa negative influence ofchanges in government consumption expenditures is consistent with Ibrahim (2000). In the Malaysian context, the crowding-out effect ofgovernment spending coupled with inefficient operations of non-financial

public enterprises seem to outweigh any benefits brought about by the increase in government consumption expenditure. The negative coefficient of change in the import ratio is however quite puzzling. We contend that, in capturing the short run

dynamics of the model, changes in the import ratio work through the demand side of the economy to influence real output per capita. However, it needs to be noted that the negative coefficient of changes in import ratio does not necessarily indicate the hannfuJ effects of imports on economic growth in the longer tenn. Imports may still promote growth, for exampJe, through its influence on exports, which in tum, positively affects economic growth.

4.

CONCLUSION

This study re-examines the export-led growth hypothesis for the case ofMalaysia. We measure exports as the ratio of exports to GDP and, in line with Levine and

Renelt (1992), we also incorporate a central and robust determinant of economic growth, i.e. investment rate, in the analysis of the exports-real output relationship. The results from a basic framework consisting of real output, investment rate and export ratio are also subject to a simple robustness check by extending the model to include imports and government spending. Using standard time series procedures of unit root testing, cointegration and error correction modelJing, we find evidence for bi-directional causality between exports and real output. Central to our analysis, we find significant error correction terms in the export ratio equation, which is robust across specifications. This means that exports are not weakly exogenous. Since weak exogeneity is a necessary condition for super exogeneity, we can also conclude that exports are not super exogenous. This conclusion is substantiated by our super exogeneity test.

This result weakens the case for the export-led growth hypothesis. In the Malaysian context, the Lucas critique applies. That is, the relationship between exports and real output is not invariant to policy changes or regime shifts. From a policy point of view, although export-promotion policy has been credited for the success of fast-growing Asian economies and is recommended as an important

engine of growth for other developing countries (World Bank, 1993), the implementation of policy requires caution. Also, recommendations based on econometric estimation assuming parameter constancy is precarious since parameters

of the model are subject to structural changes and regime shifts, as envisioned by Lucas (1976).

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